If you are the owner of a company, chances are you receive a regular stream of "cold" calls from private equity firms, competitors and strategic investors who want to talk to you about your business. Some of them resort to sales letters instead, inviting you to call them so they can tell you how they can make your very good company a great company. Some will tell you that you can liquefy a portion of your ownership in the company and continue in your operating role, if you desire, often while retaining some upside through continued ownership in the business or through the receipt of additional purchase price based on the business' achieving certain financial goals over a period of time, commonly referred to as an "earn-out."

What makes you so interesting to these investors? Over the last two decades, billions of dollars have been raised by middle-market private equity funds to invest in or acquire companies like yours. They are looking for mature, midsized companies with revenues of $10 million on the smaller end to $500 million at the larger end. Each private equity fund will target a certain size company, and many will further narrow their focus to certain industry sectors where the partners in the private equity firm have developed some expertise or in which one of their portfolio companies already focuses. Private equity firms already control nearly half of the middle market as measured by value, up from around 10 percent just 20 years ago, according to one estimate.1 Chances are, you have seen some of your business associates or even competitors involved in sales to, or recapitalization by, private equity firms.

If you are ready to sell, you may be tempted to answer some of those solicitations. What if you are not ready to sell? What if you would like to take some money off the table and continue to grow your business? Or, what if you just want to survey the market and have some meetings to take the pulse of the private equity firms? Or, what if you, like so many owners of small- and mid-sized companies, are faced with a more complex imperative, such as the purchase of a smaller competitor, the desire to follow your largest customer into a new market or the need for additional capital merely to enable you to grow your business? What if you do not have the knowledge, contacts, management capacity, bank credit or other resources to make it happen? Without help, you may not be able to take advantage of these opportunities. If you are not growing, you run the risk of losing market share—for instance, your competitors may access private equity capital and seek to attack your business—thus, standing still is most often not an option.

Private Equity May Offer a Solution

A few decades ago, your only choice may have been to sell the business before it was too late or carry on and hope for the best. If you were lucky and your needs were not too great, you might have been able to convince a bank to lend you more, or to find a silent partner willing to make an equity investment. With so many middle-market private equity firms offering so many different kinds of financial products as well as other support and value, including operating partners who have actually run businesses and managed through some of the challenges confronting you, business owners have a wide array of financing alternatives and access to varied operating roles.

No one has all the answers on how best to transition through such inflection points, but one thing is apparent: Answering cold calls is not the best way to find the right investor for you and your business. Even if you are not ready to sell, it is a good idea to understand your options and be well advised and prepared ahead of time. The best preparation begins more than a year before you are ready to put your company on the block or take in a major investor. Do not let your exit be an accident!

In our Owner's Manual, we discuss a range of options available with a private equity firm, touching on what would be gained and what would be given up in each scenario. We include a section on how you can prepare your company for an investment by a private equity firm and how to shop for the best advisors and investors. Of particular note, we also address wealth planning opportunities for the entrepreneur and his or her family. Finally, an understanding of how private equity firms operate is vital before you consider taking capital from any of them. You always want to know from whom you are taking capital and the nature of their end game. The basic private equity firm structure is for the firm to form one or more "funds" as limited partnerships. The private equity firm then secures the funds that enable it to invest through capital commitments from such institutions as public pension funds, corporations, endowments and high net worth individuals, all of whom become limited partners in the fund. A fund generally has a life of 10 to 12 years, with the ability to extend for two years in order to conduct an efficient liquidation of its investments.

Private equity funds generally invest their capital in companies (such as yours), which they call their "portfolio companies," over a period of five to six years and generally look to sell, or "exit," four to six years after their initial investment. Exiting an investment permits the fund to distribute the proceeds of a sale to its limited partner investors. Funds vary in how they manage their investments in portfolio companies—from taking a totally passive role in the management of the portfolio company to playing an active role in day-to-day operations. You should ask for references from CEOs of other portfolio companies in which a particular private equity firm has invested, as well as ask the fund managers penetrating questions. You will be partners, just as in a marriage. You want to make certain that you know your potential mate.

Considerable capital is out there. You can have your choice of how much outside investment to take on to finance your growth, how much money to take off the table and what will be your future operating/management role in your company. There are myriad players and opportunities from which to choose. Here are a few points to start your thinking.

Footnotes

1 Richard Trottier, Middle Market Strategies: How Private Companies Use the Markets to Create Value, page 88 (John Wiley & Sons, Inc. 2009).

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