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  I’ve had a couple of conversations recently with people who have made private equity deals and with some who are thinking about it.  Private equity can be the right choice for some, but for many it’s the wrong decision.

Private equity is interested in one thing: maximizing the return they get for the shareholders of their fund.  Most private business owners that I know have other things that lead the list of important things their business should do.  This is where a disconnect happens between private equity firms and owners who take this funding as part of their businesses capital structure.

If you are considering or have recently done a private equity deal here are some things you might want to consider:

Are you willing to change how you think about your business?  If you’re like many business owners you truly care about the stakeholders in your business.  If you do a private equity deal some of those stakeholders will fall by the wayside.

These stakeholders might be your employees, suppliers, the community, or the customers of your company.  Your job moves from only keeping stakeholders happy to maximizing the financial return of the company.

Do you understand what the motivating factors are for the private equity firm?  Many private equity firms have a hurdle rate (required return) of more than 25% return on investment every single year.  A private equity firm wants to usually hold your company for five to eight years and then find another buyer to cash them out with a very handsome return.

This means you will have to grow your business very rapidly.  While growing the business you’ll have to understand that you will need to do this with little cash because the private equity people will not want to put more money than their original investment into your company.

Are you aware of the capital structure of your company after you do a deal?  A typical private equity deal will have five dollars in debt for every dollar in capital the new investors put into your company.  Your company is now on the hook for this new debt.

Besides running and growing the company you and your company will now be responsible for paying this debt back.  If you have a bad year the private equity firm you thought was in your corner may quickly move to being an adversary.

Your agreement with the private equity firm is likely to have a take over clause.  This means that if you don’t hit pre-arranged financial performance numbers you will be asked to leave and someone will take your place.

Many private equity firms will tell you that everything will stay the same after they make the investment in your company.  They will also say that their takeover clause is only reasonable since they have put so much money in your company.

Private equity firms have learned that for them to get the financial returns they expect, they will often have to change senior management, including and especially the founder of the company.

Private equity might be the perfect thing for you.  Before you take the plunge, spend some time running your company maximizing the return and economic value of your company.  If you enjoy doing this, then private equity could work out well for you.  If not, choose another path to having a liquidity event in your company.

Josh Patrick

If you want to see how your business measures up, click on the button below to learn more about our Stage 2 Strategic report.  This report will give you some important information about where your business is in creating enterprise value.


Securities and Investment Advisory Services offered through NFP Securities, Inc. (NFPSI), Member FINRA/SIPC. Stage 2 Planning Partners and NFPSI are not affiliated.

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Topics: for business owners, Private Equity, strategic planning

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