Selling your company more than once — PE Magic #1
Having been through a private equity-backed MBO twice now I’m only one step from being a PE veteran. Very few entrepreneurs get to do one of these deals in a lifetime never mind two or three and that means that actually it’s quite hard to find an expert. Like many things in life, every PE deal has it’s own nuances so many people can only give you perspective from one piece of experience. I can give you two — which is at least a 100% improvement on the norm!
“You sold your business — so what you going to do now?”
“Errr. Well actually I’m going to carry on doing my job.”
That’s something I get asked all the time, so I thought I’d start this blog section to try to explain what it’s all about. Hopefully I’ll create a tiny snitch of clarity into an area that’s a little opaque with its own jargon and lingo.
Growth Private Equity investors back entrepreneurs and management teams — that is key to their model.
This is the first thing to understand. And notice I specifically said “Growth PE investors” — there are several types of PE investor and here I’m talking about Growth investors specifically — I’ll write a post about the different types of investor shortly.
So growth PE investors back management teams. They do that because they’re experts in investing and their experts in finance and sometimes financial engineering, but they’re not experts in driving a business forward in a market or operational execution. Sure they’ll have seen things go well and go badly in the past but they’re not there to run the business for you or for anyone else — thats what entrepreneurs and management teams do. It took me a while to believe this but I can tell you truly and honestly it is completely true.
Private Equity vs Venture Capital — where does the money go?
OK, so PE is very different to VC — Venture Capital. The difference in a nutshell?
- When a PE firm buys a company the money they pay goes to the shareholders of the company. It doesn’t go into the company’s bank account, it goes into the shareholders bank accounts.
- When a VC invests in a company the money (or the vast majority of it) goes into the company to fuel it’s continued operations and growth. Little or none of it goes to shareholders.
That’s why you see VC’s investing in start up businesses that don’t make a profit yet and need capital to expand and you see PE firms buying more mature businesses that can survive themselves on their own cash flow.
And how do you sell your business more than once?
Well remember — PE investors back management teams. So they want to back you the entrepreneur or manager. So you’re only going to sell them part of your shares — that’s key. When you’re selling to PE as a “continuing manager” then the PE firm will generally want two things, which have a natural tension between them :
- You to have enough “cash out” or “shareholder liquidity” to get the deal done, make you happy and give you a level of personal financial comfort so you can focus on driving the business forward without worrying about your mortgage
- You to “reinvest” or “roll over” enough of the value of your shareholding back into the business to show them that you are confident in the businesses future, you are a significant shareholder in that future and to give them the confidence to back you and follow your lead. Remember — they’re backing you.
So how much will you roll over? As a rule of thumb start thinking about 50%. 50% shows you are equally a buyer and a seller. Rolling over 55% shows you are more a buyer than a seller — it might make only a small difference to your cash out but its an important statement to your PE investor of your confidence in the business and that can make all the difference to you getting a deal done and good terms elsewhere.
And for those of you wanting to leave?
If you want to leave, retire, spend the rest of your life on the beach? Remember — PE backs management teams to run the business and create future profits. So if you want to leave, retire or run for the hills you only have two options really :
- Replace yourself first — find, nurture and train a new CEO or management team, move yourself to “Chairman” or “Founder” status and get your hands off the day to day operation. Have that new team present and sell the business to the PE firm and position yourself as a nice figurehead but not essential.
- Find a PE firm that specialises in transitioning founder managers out and replacing them with a new management team. But beware that this is a much smaller pool to fish in and the valuation of your business will likely reduce as a result.
There’s more, but not for today.
There is some nuance about rollover maths that I’ll blog about separately. And I also need to explain the magic of “sweet equity”, more commonly executed as “stock options” in the US. With sweet equity you can end up owning almost as much (if you’re very lucky — more) equity in your business after a deal than you did before. But that’s definitely a separate blog post,