The Role of Private Equity in Acquisitions: What Business Owners Need to Know

Private equity (PE) has become a driving force in mergers and acquisitions, reshaping industries and providing opportunities for business owners to capitalize on years of hard work. Whether you're looking to sell your business or seeking growth capital, understanding how private equity firms operate and assess acquisitions is crucial. This white paper provides an overview of the role of private equity in acquisitions and offers insights into what business owners need to know to engage effectively with PE buyers.

1. What Is Private Equity?

Private equity refers to investment funds that acquire privately held companies with the goal of increasing their value and generating returns for their investors. These funds are managed by professional investment firms that raise capital from institutional investors, such as pension funds, endowments, and high-net-worth individuals.

• Key Characteristics of Private Equity:

• Focus on long-term growth and profitability.

• Typically acquire a controlling stake (51% or more) in businesses.

• Operate on a timeline of 5–7 years to grow and sell the acquired company for a return​​.

2. Why Private Equity Targets Certain Businesses

Private equity firms are selective in the businesses they acquire, focusing on those that meet specific criteria.

Key Attributes PE Firms Look For:

1. Consistent Cash Flows: Businesses with steady, predictable revenue streams are highly attractive.

2. Growth Potential: Companies in industries with strong growth trends or opportunities for expansion.

3. Strong EBITDA Margins: Firms prefer businesses with at least $3 million in EBITDA, though add-on acquisitions may require less.

4. Low Customer Concentration: Businesses with diversified customer bases reduce risk for buyers.

5. Scalability: PE firms seek companies with potential for operational improvements and economies of scale​​.

3. Types of Private Equity Acquisitions

PE firms engage in various types of acquisitions, each with a unique strategy and purpose.

A. Platform Acquisitions

Platform investments are initial acquisitions in a specific industry. These are typically larger businesses that serve as a foundation for future acquisitions.

• Example: A PE firm acquires a healthcare company with strong operations to build a portfolio of related businesses.

B. Add-On Acquisitions

Add-ons are smaller acquisitions made to complement or expand an existing platform. These acquisitions are often used to capture market share, expand geographically, or add new product lines.

• Example: A PE firm adds a niche MedSpa chain to its existing platform in the aesthetics industry​​.

4. How Private Equity Firms Assess Acquisitions

PE firms use rigorous criteria to evaluate potential investments.

A. Due Diligence

Due diligence is an exhaustive process where the firm evaluates the financial, operational, and market health of the business.

• Focus Areas:

• Financial statements, including normalized EBITDA and historical performance.

• Market conditions, including industry trends and competition.

• Operational risks, such as customer concentration, supply chain dependencies, or reliance on the owner​​.

B. Valuation and Deal Structuring

Private equity firms typically assess a business’s value based on its earnings and growth potential.

• Valuation Metrics: Multiples of EBITDA are commonly used, with the multiple varying by industry, market conditions, and growth prospects.

• Deal Structures: PE deals often include creative structures such as earnouts, equity rollovers, or performance incentives to align the seller’s goals with the firm’s strategy​​.

C. Growth Strategy

Private equity buyers often have a clear growth strategy for the companies they acquire, which could include:

• Geographic expansion.

• Operational improvements and cost optimization.

• Cross-selling opportunities across portfolio companies.

5. Benefits and Risks for Business Owners

Engaging with private equity can offer significant advantages but also comes with considerations.

Benefits:

• Liquidity: PE buyers often offer competitive prices with the option for partial cash-outs.

• Growth Resources: Access to capital and expertise for scaling the business.

• Retained Equity Upside: Owners who agree to equity rollovers can benefit from future growth​​.

Risks:

• Loss of Control: Majority stake acquisitions may reduce the owner's decision-making authority.

• Aggressive Growth Timelines: PE firms prioritize rapid returns, which may conflict with the seller’s long-term vision.

• Cultural Shifts: Employees and management may face operational or cultural changes post-acquisition​​.

6. Preparing to Work With Private Equity Buyers

Steps to Prepare Your Business:

1. Clean Up Financials: Ensure financial statements are accurate, transparent, and normalized.

2. Highlight Value Drivers: Emphasize recurring revenue, operational scalability, and growth opportunities.

3. Address Risks: Mitigate customer concentration, reliance on key personnel, or outdated processes​​.

4. Hire Advisors: An experienced M&A advisor can help navigate negotiations, market your business, and secure optimal terms​​.

7. Conclusion: Is Private Equity Right for Your Business?

Private equity offers a unique opportunity for business owners looking to sell or grow. By understanding how PE firms operate and what they seek, you can position your business as an attractive target and negotiate terms that align with your goals.

Take the Next Step: If you’re considering a sale or partnership with private equity, consult an M&A advisor to assess your readiness and maximize the value of your business.