The New Role of Private Equity Firms

The following is a guest post from Nate Nead, an investment banking Director at Merit Harbor Group, LLC. Nate’s practice focuses on software, technology, energy and manufacturing. He and the Merit Harbor team work with middle-market business owners looking to grow, acquire or sell companies in the $10mm to $100mm valuation range. He works out of the company’s Seattle office.

It wasn’t too long ago when private equity firms had the power – and ability – to do very little heavy lifting in order to enjoy a substantial growth on their return in a short period of time.

But times are surely changing. With recent high company valuations and other general macro-economic factors, investors need to get far more involved with a company in order to expect any type of fast growth. Earning returns from investments is harder than ever before, forcing private equity firms to prove that they have something to offer companies. That’s why, in recent years, we’ve seen more and more private equity firms create a post-acquisition value for their portfolio companies.

Today’s private equity firms need the skills and strategies in place to grow revenue and cash flow, in order to maximize the investment exit.

Increasing Competition for Deals

Private equity firms are finding themselves outbid as valuations are increasing to all-time highs, including at 10x cash flow. These PEGs find it difficult to compete with what multiple strategic buyers can afford, and with these increasing valuations, are finding it more challenging to get the return they need to rationalize the investment.

As a result, private equity firms have had to step up their game in order to offer something unique. It seems they’re doing just that. More and more firms are choosing to stay involved, according to GF Data. In fact, 90% of the buyouts GF Data tracks included a post-management solution or continuity in 2015, much higher than in previous years.

Less is More

Generally speaking, private equity firms want to acquire between 51% and 100% of a business. In order to stay involved, management is typically asked to roll over equity. As a result, a PE firm might own around 85% of the company, and will likely retain some control over board seats. In addition, the private equity firm might also include operating partners as board members. Day-to-day operations are often times left to the company’s existing management team.

So why would a company want this type of more-involved arrangement? Well, think of the alternative. If a company is sold to a strategic partner, then chances are that the management team will lose control of the business.

On the other hand, a company with a strong management team that sells to a private equity firm is in better position to bring that company to the next level, as a result of gaining access to:

• Additional capital
• Operational and professional expertise

One of the shifts we’ve seen in recent years is the decline of the private equity firm that brings in an operation team after acquiring a company. This shift falls in line, perfectly, with the PE’s increasing role. As private equity gets more involved post-acquisition, it’s important that a company grow familiar with the private equity fund’s management team. A rapport should be built so that everyone remains clear and focused on the growth goals outlined.

So long as the PE firm has the expertise to be heavily involved (and typically that means that the investing principals have operating experience) then this evolution can result in great returns in the future.

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