What Are The Secrets Of Private Equity?
Private equity is a many-splendoured thing. To some, the spectre of greed on a massive scale, to some, a benefactor or savior, to others, merely a tool of growth.
Since 2013, the value of private equity buyouts globally has gone from $487.97 billion US to $825.77 billion in 2018 (source). One of the most significant recent buyouts is the Dell purchase of EMC Corp, for $58.1 billion in 2016 (source).
In 2017, Apollo Global Management raised the largest single pool of capital, weighing in at $24.56 billion (source).
As opposed to the typical buyout goal of public companies, which is to acquire to complement or expand current business operations, private equity’s modus operandi tends to be buy-to-sell. This strategy comprises of the following tactics:
• Competitive incentive for both investors and operating managers
• Liberal use of debt
• Exploitation of financial and tax advantages available due to significant freedom from regulation that constrains public companies
• Aggressive working capital management
All of these combined serve to drive up the value of the acquired company so that a nice profit is realized upon the sale, typically three to five years later. Whether for bad or good - as determined by the viewer - private equity deals certainly achieve high returns.
In all the furor over these mega dollar deals, private equity seems an option solely for the benefit of the largest and best-funded capital firms. As a private equity practitioner myself, I will contend, however, that individuals can use the same tactics of the larger private equity firms to serve the interests of small and medium business enterprises.
Thousands of small to medium sized businesses are available on the market today or coming available soon. The main factor in this is the aging Baby Boomer population, the denizens of which are reaching retirement and wishing to decrease their hands-on involvement or to sell their businesses altogether. Many of these are family-owned and operated businesses, and the owners either have no heirs or find that their heirs are unwilling or incapable of running the business.
Additionally, one need not look far to find businesses that are struggling, either because of economic circumstances or mismanagement. The individual looking around in his or her community should be able to find one or several businesses to purchase, with intent to run themselves, rescue, merge for growth, or sell at profit.
A buy-to-sell model on the SME scale is ideal because when a sale within a set number of years is the goal, the focus is always on improvement and increased value. Time and resources are not lost in efforts to form entangling alliances with which to share operations or costs. As a result, valuation at the end of the life of the fund is set on accurately accounted-for returns, which in turn makes it easy to calculate incentives for investors and the business managers.
So what are the secrets?
Private equity pools are increasingly accessible for purchase of small to medium businesses. Certain private equity investors and shadow capital investors may wish to be more involved than blind pool equity investors, preferring to be sure that their resources fund only certain types of business or remain within a geographical region. These sources of capital would be desirable for financing a small to medium sized buyout, keeping the money local, so to speak: their way of giving back in tangible ways.
An individual private equity operator certainly must be as savvy as the big time operators, and all the tasks fall to the one individual or the handful of partners. The first required skill is identification of a good opportunity, including the one or two operations to be leveraged for the highest increase in value. Skill and care are also required in the running of the newly purchased company, both in dealing with the existing staff or placing a manager and in tightening up revenue, margins, and cash flow. The ability to size up a situation and make quick and smart decisions is paramount. Finally, the ability to negotiate the buy and the sell will also be critical for a small PE manager.
At the SME level, individual PE operators will be engaged face to face with the companies they have acquired, and this will require a gentle touch in order to avoid the perception of a hostile takeover that accompanies so many of the larger dollar transactions. This is an opportunity that PE owner-operators will have - more than simply enjoying their own success - to bring positive impact to the lives and communities in which they choose to invest.
