Transcript for:
Understanding Private Equity Dynamics

In the fall of 2001, I found myself standing in the kitchen of a Domino's pizza. The man I was with opened up a drawer, pulled out some dough, and flattened it, applied some sauce, sprinkled on some cheese, and put it on a conveyor belt. I watched as that pizza disappeared into a large commercial oven. Moments later, I could smell the aroma of freshly baked pizza. And shortly thereafter, it emerged from the oven. A freshly baked Domino's pizza. The man that cooked that pizza was Sele Bassul, the CEO of Middlebe Corp. The Domino's Kitchen I was in was a mock Domino's restaurant, not unlike the dozen other restaurants that were within the warehouse and manufacturing facility of Middlebe in the northwest side of Chicago. Sele was there to demonstrate the power of Middleb's technology and discuss with us the proposed acquisition of logic. At the time, I was an analyst at American Capital, the largest publicly traded private equity firm in the United States. And Seline was giving us a demonstration of how his oven technology allows Domino's Pizza to cook and deliver 80 pizzas per hour on a single Middle oven. Middleb was on the verge of something big. They weren't simply satisfied with making the best ovens. They wanted to be the undisputed leader. But in order to do that, they needed more than innovation. They needed capital. In this deal, like every great private equity transaction, wasn't just about buying a company. It was about engineering an outcome. Because private equity isn't about transactions. It's about transformation. It's about taking something that already works and amplifying it. Using capital, leverage, and strategy to turn an already strong business into an industry juggernaut. [Music] I'm Paul Gammore. I'm an investment banker and I negotiate for a living. Today we're going to talk about private equity. What is it? What does it do? And is partnering with private equity right for you? At its core, private equity funds pull capital and they invest them largely in privately held business. And now I say largely because at times there's investments made into publicly traded companies from private equity firms. And those are referred to as pipes or private investments in public equities. But for our purposes today, we're going to focus exclusively on the investment of the pool of capital into privately held businesses. And private equity firms do that largely in one of two ways. On the one hand, we have a buyout shop. And a buyout shop, just like American Capital, would largely acquire between 51% 100% of a business. They want to buy a controlling stake in a firm. Then on the other hand we have minority or growth equity investments. And I typically will batch VC or venture capital into that mix. And a minority investment or a growth equity investment is taking a minority stake in a business 20% 25% 30% in order to assist the company with growth with the eye on an IPO or some other exit at some point in the future. Now, private equity firms get their investment capital from a variety of sources, whether it be a retirement fund, a sovereign wealth fund, uh, or even individual investors. I, for example, invest individually in private equity funds. An example of a private equity fund formation would look like this. We have two or three guys that either have industry experience or perhaps come out of investment banking or perhaps even leave another private equity fund. They get together and say, "Hey, let's raise our own fund." And what they do is they set up a general partnership and that general partnership invests into a limited partnership. So kind of a closed end limited duration partnership. In the US we tend to see it about 10 years is average. That general partnership will put capital in sometimes 5% sometimes 10% of the total amount expected to be raised. And then the practitioners of the private equity professionals go out into the community. They deal with pension funds, retirement plans, so on and so forth. They raise capital from limited partners. So those limited partners now are partners in the fund. And as the private equity professionals begin to deploy that capital or make buyouts or make minority investments in the first two to three years of the fund, that's when they're deploying capital. And as they are deploying capital, they're calling it. Meaning on the front end, the investors aren't necessarily writing the check for the full amount. So in this particular example, let's say it's a $100 million fund. You've gone out, you've raised $100 million. I'm your investor. I say, I'm going to commit 10 million to the fund. I'm not writing a check for $10 million today. I'm writing a check typically as it gets called over a period of time. And that might be one year, two years, three years, so on and so forth. But as private equity firms call in that capital, they deploy it. And by the time they get into the middle of the fund, that's when they're really focused on the value creating aspect of holding portfolio companies, which we're going to talk about today. Finally, when you get to the end of the fund life cycle, that's when the private equity firm is ultimately looking to divest or exit its portfolio businesses. And those exits typically are either public offerings or sales to other private equity firms or sales to strategic or uh industrial buyers, for example. Now, one of the questions I get often is how do private equity funds actually make money? And here's how they do it. They private equity firms get their returns kind of the same way that you, a business owner, would get a return to your business. Capital appreciation and dividends for a business and private equity capital appreciation and management fee. So when the general partner sets up a fund, the fund raises capital. On the capital that the fund collects, it typically takes a management fee. Now in the United States, that can range anywhere from a few basis points all the way up to 2 3 4%. In the industry over the years, we've typically heard about 2 and 20, which is a 2% management fee and a 20% carry or 20% of the upside in capital appreciation goes to the private equity fund. And let me give you an example of that. Let's say that this private equity fund that we just established is a $100 million fund. It raises $100 million and begins to take a 2% management fee on the assets that it manages. It goes out and deploys some capital and it buys a $10 million business. And let's say it buys a $10 million business in year 1 and in year 7 it exits and that business is a $30 million business. At that point in time, the capital appreciation, the 10 million that we started and the 30 that we exited was 20 million, right? That's the delta between 30 and 10. So we've got 20 million in capital appreciation. the private equity firm will take 20% of that capital appreciation. So in this particular case, we're talking about $4 million plus the 2% that has been taking over time. And later in this series, I'm going to talk a little bit about management fees and I'm going to talk a little bit about carry because every private equity fund is different. And I think it's important for business owners to keep in mind that some private equity firms if you were to partner with them. So they let's say for example do a control buyout of your firm. You've sold them 70% of the business. You've retained 30 for yourself. Some private equity firms will actually take a management fee on your own business, the business that you've partnered with. And others will not. They'll say we'll partner and Perry pursue with you. We're not taking a management fee because we're partners. Other private equity ter firms will take a a straight 20% carry a straight 20% of that off the top. Others will have specific required rates of return for their limited partners for example before they get paid. So there's a little bit of a nuance in the deal structure that I think is important to pay attention to. But we'll get into that a little bit later in the discussion. [Music] Now, in the previous example that I gave you about American Capital's investment in Middle B, American Capital was one of the largest private equity firms in the United States and certainly the largest publicly traded one. And it was typically a buyout shop. I mean, American Capital largely focused on control buyouts. They wanted to buy businesses that they could take control of, do acquisitions over time, focus on growth, and exit in the future. In the particular case of middleby, it was late 2001. We had just had the.com bust. We were immediately after the terror attacks of 911. So the capital markets were particularly difficult to tap and that's where um private equity stepped up. You know, banks weren't interested in lending. Middle wanted to make the acquisition of the logic. They went out to traditional lenders who had really no interest in taking the risk at that point in time. So they called in private equity and that's where American Capital stepped up. So in late 2001, American Capital invested $25 million in convertible debt and equity and got a 5% stake in Middlebe. American Capital exited one year later for a 37% return. Now that's an example of a growth equity investment. It wasn't a control stake in Middle. It was a minority stake in Middbby. And American Capital provided that capital specifically for the purposes of middleby doing the acquisition of logit. Now you could look at that and say wow 37% return that's great for the private equity investor not so great for middleby. It it ultimately turned out to be a slam dunk for middleby and it was quite frankly expensive capital right equity capital typically is more expensive than debt capital but when no other capital exists sometimes you have to do what you have to do. So allowing private equity come in and fill that gap was the only way that Middleview was going to get that acquisition done. That's a prime example of how private equity can step in um do a growth equity investment for a specific [Music] purpose. Now, as I mentioned at the beginning of this session, private equity firms aren't just interested in transactions. They're attempting to engineer outcomes. So they're trying to purchase or acquire businesses that are already operating and thinking through the additional capabilities and resources that they can add to those businesses in order to make them more valuable in the future. So if you think about it, private equity gets its biggest bang for its buck from capital appreciation. And so if you're a business owner and you partner with private equity, if you are literally equity partners with a private equity firm, your interests typically are 100% aligned because both you and the private equity firm want to increase the value of the firm. And so private equity typically comes in and does a variety of different things in order to help create growth. For example, private equity firms will come in and focus on corporate governance. A lot of middle market businesses don't have effective boards or corporate corporate governance processes and procedures established. So that's important from a private equity perspective to do that. Additionally, it's very difficult for middle market businesses to access or tap the capital markets, even the debt markets. So by partnering with a private equity fund, middle market businesses now have the ability to tap the debt markets in ways that they can't on their own. And you could take like a typical $50 million residential services business. Now might be able to get some senior lending from a bank for a couple of million bucks, but in partnership with a multi-billion dollar private equity fund. Now that business can go out and borrow 5, 10, 25, $30 million, whereas before it couldn't. So private equity provides access to capital. It also provides you know not only debt capital but also equity capital. In addition to buyou shops and growth equity investors which are two broad classifications. There are literally thousands and thousands of private equity funds across the world. It's a $6 trillion global industry now in 2025. And private equity firms come in all sizes and shapes. For example, you have private equity funds that focus on the quick service restaurant industry, consumer products. You've got some that focus solely on residential commercial services. Private equity funds over time have begun to really specialize. Back when I was at American Capital, it was a generalist shop. American Capital would look at anything and we invest in Piper Aircraft case logic, a toll booth operator, a pneumatic valve manufacturer, middleby oven manufacturer, whatever it was, you name it, American Capital would look at it. And American Capital looked at about when I was there, they would look at about 4,000 transactions per year. There were 4,000 deals that would come in for us to look at and assess. And we had a pretty stringent process. We had an investment committee that sat at the corporate headquarters. We also had deal committees at each different office. And at the time, American Capital had 10 offices when I was there. But we would roughly look at 4,000 deals per year, whittle it down to about 450 that we would start to do some preliminary due diligence, ultimately submit proposals to the investment committees. Um, and the investment committee would approve somewhere between 1 and 1.5% of those deals. So somewhere between, let's call it 40 and maybe 60 transactions would get done per year out of those 4,000. That's a typical private equity funnel, right? It starts really broad looking at a lot of transactions and gets pretty narrow. Now, some private equity funds are more thematic investors, meaning they will either entirely focus on an industry or a vertical or they will choose three or four different verticals to focus on. They might have one fund that does a few different sectors or they might have multiple funds, each fund doing its own sector. There's a variety of ways to do this. But when we talk about thematic investment, that's when a private equity fund develops a thesis like I want to roll up the lawn care industry. It's a $15 billion industry. It's extremely fragmented. There's a lot of tailwinds, so on and so forth. I want to focus on this industry. I want to acquire and consolidate a lot of lawn care businesses. I want to bring in technology, artificial intelligence, bring in new operators, add leverage chain strategies, evolve marketing. There's a variety of different levers private equity will pull to increase the value of the business. But that's an example of a thematic investment. And when private equity funds do that, if you're a business owner out there in a particular industry, you might get a few emails per week. And some of those emails that you get might say, "Hey, this is Joe Blow from XYZ private equity firm. We are very focused in the pneumatic Valve industry and you know we're building a thesis around that. Your company seems interesting." So on and so forth. That would be an example of a company or a private equity fund that's really going to focus on pneumatic valves for example and attempt to roll out that industry. On the other hand, what American Capital did, it was more opportunistic. So, not only did we receive deals from bankers, right, investment bankers and M&A advisers would send us materials on their sellside engagements, but we were also active in reaching out to business owners. And back in those days, we did the same thing that is happening to you today. We would send out emails, we would make calls, we would try to sit down with business owners and explain to them how partnering with private equity would allow them to get very wealthy. And of course, we had our own douchebag dictionary just like all the private equity got us today, right? Like second bite of the apple, take some chips off the table, blah blah blah blah blah. But as a business owner, you face the dilemma in that um how the hell do I tell the difference from one private equity fund to the next because they all wear the same vests and drink the same coffee cups and say the same sort of things and same sort of buzzwords. And later in this series, I'm going to walk you through how I would do my own due diligence on a private equity fund. But for today's purpose, I just wanted to spell out how private equity in North America works broadly, which is buyout versus minority or growth investment. And then naturally thematic versus generalist approach, a more opportunistic approach. [Music] So when I worked at American Capital, I was a junior guy on the deal team. You know, I had done a couple years in investment banking and then I did what everyone else did. I went to the buy side. So now I'm working at private equity, right? So what I get to go out and buy companies and invest in them and grow them and sell them and it was all cool, right? I was in my early 20s at the time. I joined American Capital and my job was to basically be the front-end screener for deals among other things. So, I would get required to reach out to guys like you and say, "Hey, do you want to sell your company? We're super cool." Um, and I got materials from investment bankers. So, I'm reading these SIMs all the time, these confidential and phone memos on just ridiculous right? Um, you know, a company that tracks stat satellites, you know, this company makes aphrodesiacs for dogs. Was all sorts of stuff I was looking at. And I had to think about what could we, again, American Capital was an opportunistic acquire. So I look at a company that does, you know, I I I use pneumatic valves because we made an investment in a company called Pneumatics and they were a pneumatic valve manufacturer. And you know, when you look at that, you have to say, okay, what am I able to buy this business for? Like what do I need to pay today to get this business? What sort of add-on acquisitions are available? So if I have to pay, you know, 10 times EBITDA to buy this business, can I go out and buy a bunch of additional companies at five times EBITDA and kind of blend down my multiple? Right? So one way of doing it was through consolidation. Another way is like what other capabilities did we at American Capital have that I could apply to this business? So what did I know about strategy in this space? Um, what sort of marketing capabilities do we have? You know, was this company doing online marketing? I mean, I don't know how many pneumatic vowels were sold online. And again, this was back in 20201, but you know, do we have marketing capabilities that we could apply to it? You know, what did the board actually look like? Did we have proper governance? What incentive structures are in place at the company? I mean, so we've got ownership, but no one under ownership actually had any real incentives. There was no equity option plans. There was no profit sharing. There were no phantom stock. There there's a million different ways you can do incentive plans, but the company had none. So, how could we take some equity, pull it, and then provide some incentives for key leadership there? The other question is, I mean, is this a 100% buyout? Is this a control buyout? Is the owner somebody we actually want to partner with? Like, is the owner somebody who can really help us grow this business or is this some guy we want to boot? Could we find an operating partner? Was there some sort of samurai of pneumatic valves out there who had been carving up the world doing crazy with pneumatic valves that we could pull in from the outside and bring them into this business to help us grow it? Somebody that had to secret sauce that we don't have. We would look at the strategy, you know, and again, it's almost ridiculous when I think about it. Here I was like a 24 year old kid like trying to think about like the strategy of a pneumatic valve manufacturer. But quite frankly that's actually what's going on now to a great extent in private equity. you know, when you receive that email from a buy side broker or some analyst at a private equity fund, they've decided that they want to get into the I don't know, the sheet metal industry and they're looking at a bunch of different companies and an analyst is saying, "What can we do with this corrugated roofing and sheet siding and so on and so forth?" And they're putting together a thesis and they're reaching out to companies to see if they can find anything. And in the next part of this series, we're really going to get into deal structuring. And that's where I'm going to talk about how deals are structured, how you can protect yourself when you get those emails from private equity firms and how you should deal with it. But staying on the topic today, you know, again, my job at American Capital was to make that kind of first assessment. Um, once we found opportunities that we thought were interesting, then I had to write an investment committee memo. And so the investment committee memo was, "How much do I think I could buy the business for? What do we think that we can do with it over the next five years? So what are all the different value levers that we could pull in this organization? What would it likely be worth five years from now? And then what would be our implied return rates? Right? So if you think about deal structuring and you think about economics and private equity, private equity firms, although they talk about multiples, what they're really looking at is internal rates return on investment. Now I don't want to get too complicated and complex in today's discussion. And I think I will do a lot more videos on valuation in the future, but really when a private equity firm is looking at your business, so you're a business owner and a private equity firm comes in and wants to buy you, what the question that they're asking themselves in the background, what they're modeling is, how much do I have to pay today for a business that's going to be worth X in 5 years based on all the things that I can do with it. So they're going to say all the different value levers that they can pull to help grow this business and create create value, it's going to be worth a h 100red million five years from now. So what can I afford to pay for it now today? Assuming that I need a minimum required or internal rate of return of 30%. Right? I need a 5year IRRa of 30% or a 5year IRRa of 25% or whatever the hurdle rate is that the firm or the investment committee wants for that particular investment. That's how they're valuing your business. Now, of course, they're looking across the industry and they're looking at, you know, whatever industry you're in. You're in the fire protection industry, they're looking at what the multiples are across the board in the industry, what other private equity firms are paying for transactions. You're looking at comparable transaction statistics, so on and so forth. Um but the key overarching you know when I would write my investment committee memos you know of course the investment committee wants to know what the IBIDA and revenue multiples are in the industry but they're what they're really concerned about is my projections how accurate they may be the leverage that we can really pull and then the implied internal rates of return on the capital we're investing in those [Music] businesses. So, why would a business owner actually want to partner with private equity? Let's think about this from my day-to-day work life. The one that I come across most often is the business owner who actually has no interest in partnering with private equity. He or she just wants to exit the business. It might be somebody who's 60 years old and says, "Hey, Paul, I want to sell my business. I'm going to get the absolute best price I can for it." We run a full process, meaning we go out to private equity firms. We go out to strategic acquirers. We run a process and we get to the end and lo and behold, the private equity firms are leading in terms of terms and price. Now that owner has to look back and say, "Well, man, I never thought about partnering with a private equity firm, but this priv private equity firm said my business would be a great platform acquisition and the price is right, the terms are right. I'm not wild about rolling." And when you say rolling, that means rolling some equity into new co. That means, for example, the private equity firm buying 85% of the business and the owner retaining 15%. But sometimes what happens is, I'll give you an example. Last year I ran a process on a business um that ultimately sold for $75 million. And the majority of the strategics in the private equity firms from a valuation perspective were in the 50s and 60s. We had one private equity firm that wanted that company as a platform and was willing to pay $75 million bucks for it. Um, but they wanted to put $60 million down in cash and have the owner roll 15 million uh into NCO. So, the owner would walk away with $60 million and own a percentage or 15 million in equity of the new company. And while the owner wasn't wild about that, was not interested in running that company going forward, the private equity firm made it a requirement that the seller roll equity and be a partner. And the seller looked at it and said, "Well, wait a minute. Even with the cash that I get at the closing, I am just as good as the all-in purchase price from everyone else that was at the table. So, I got $15 million in rolled equity for free. I'm going to do that deal." Now, that particular owner sold that business last year. took a step step back. His management team is running that business and the private equity firm is now continuing to do add-on acquisitions. They've hired an operating partner. So, they've gone out into the industry. They've replaced that selling shareholder. They put a new individual in charge of that business. Now, they're doing add-on acquisitions. He got a 60 million bucks and now he owns 15% of new co. And when that private equity firm exits 3, four, 5, 6 years down the line, he'll get ideally a return on that investment. Of course, that private equity firm is focused on at least a 3x return on that money. So, in a perfect world, he walks away with 45 plus million. That's the typical seller that I would come across on a day-to-day basis. I would say the next typical after that would be the seller who says, "Well, I'm 45 years old. I've got a business that's worth 50 million bucks. I um I don't have any money outside of that, right? Like I have all of my chips in this basket. The business is growing well. I think I can take it to 100 million. Um but it would be nice to have some additional investment capital. I certainly would like to take some quote unquote chips off the table. I'd like some liquidity. I'd like to be able to pull 5, 10, 15, $20 million out of this business now in order to buy the vacation home, take the vacation, and do the types of things that I want to do while still maintaining control of this business. I want to be the majority shareholder. I want to be able to call the shots, but I would like to have a partner that can help me do acquisitions because I've never done acquisitions before. That can help me revamp my marketing program, that can help me hire a CFO. I don't, you know, my CFO is a glorified accountant at this point. I really could get a new CFO but I'm not quite sure how to do that or the best way to go about it. So in that particular case we would run a formal process like we always do. Um we would bring in strategics always because the strategics help us get an understanding of valuation um and option. Um, but we would end up with a small handful of private equity firms that would have expressed interest in that business. And the seller could now start to think through, do I want to sell 70% of the business, 80% of the business, 90% of the business? You know, how much do I want to pull out? How much will I want to roll into new co? What sort of participation will I have going forward? Most of the time they want to continue to be CEO. Um, and so they might find themselves in a situation where they're a platform acquisition for a private equity firm looking to get into that industry in a particular geography. They can roll equity, remain on a CEO, the private equity firm backs them, allows them to do acquisitions, so on and so forth. Private equity deals also come in the flavors of 100% change of control. And that's often when you know you might have a lawn care business or a fire protection company or a waste management firm that is owned by a private equity firm. It is a platform of a private equity firm. And when I talk about platform, I mean it's a portfolio company. You got private equity firm ABC has a fund. That fund invested in the weight man waste management industry and owns waste management company XYZ. Now waste management company XYZ the portfolio company is now going out making acquisitions right and typically the targets of that XYZ waste management firm would have the ability to either sell 100% do 100% change of control deal with Waste Management XYZ or at times would also be able to roll equity. So, they might sell their business. Maybe they've got a $10 million or $20 million waste management firm. They might be able to sell that $20 million firm and sell only 80% of it and now convert some of that purchase price into equity of XYZ. So, now they're a partner of the platform portfolio company. Um, and they've taken some size sizable capital off the table of 70 80 90%. That's a pretty plain vanilla deal. We do dozens of those every year. We see those all the time. Um I think from a participation perspective, when you start to think about private equity, the guys that actually have to be deliberate about this process is the second individual. The individual who wants to continue to grow the business, wants to take on a financial sponsor. And when I say financial sponsor, I use that interchangeably with private equity. Wants to take on a private equity firm and partner with that private equity firm. um grow the business and exit at some point in the future. That's when the seller needs to do a lot of due diligence on the private equity firm because they're all very different yet they sound the same even to me. And later in this series, I'm going to talk extensively about how business owners can think about the differences between private equity firms, how to do your own due diligence on PE firms, and how to make a decision. Those scenarios I just discussed are are change of control scenarios. Now, over here at Ptoic, I deal far less with minority positions. But when you think about a minority investment from a private equity firm, that's typically a larger firm that is looking to number one maybe get a little bit of liquidity, take a few bucks out of the business. Um, but really when folks take on growth equity investment, they're actually looking to grow. They might have a great uh acquisition opportunity like MetalB acquire our largest competitor, right? That's a great opportunity. They might have some AI technological investments that they want to make. They might be building out a sales force. There's a variety of reasons why a firm might tap a private equity firm for a minority growth investment. And so of course the capital is extremely a visible aspect of that. But there's also a lot of other important reasons in res commercial services. You might have a $500 million a year in revenue business that would ultimately like to go public. It's really hard going from a privately held business to ultimately taking it public if you have zero experience taking a business public. So sometimes folks who have the aspiration of ultimately taking a business public and say we need to partner with a private equity firm that does this for a business, a firm that has made a bunch of investments over the years and taken a lot of these companies public because they're going to understand how to structure the board. They're going to understand how to structure the corporate docks and governance. They're going to be able to bring a lot of other resources and capabilities to help us grow this. And it won't when it comes time, they will actually lead us down the path to an IPO. So, we tend to see that from time to time. Outside of taking chips off the table and getting the old second bite of the apple, why else would you consider partnering with a private equity firm? Well, what do private equity firms bring to the table? The most visible aspect is capital, right? They bring in growth capital and they bring in diversification in capital for you, the owner. They bring on additional access to capital, right? You own a $100 million uh commercial services business. You can tap commercial banks, right? You can get capital, but you certainly can't get it as much as a billion-dollar private equity firm can, right? They have lenders on tap. They can very easily tap the debt markets in ways that you can't. And debt is significantly cheaper than equity capital. And if you've got a lot of growth plans, getting an expensive debt might be a great thing for you in order to grow your business. So, access to capital um access to other resources and capabilities. is when I look at private equity firms, I'll typically look across their portfolio and usually private equity firms will have specific concentrations, right? So you might have a firm that focuses on digital marketing. So the private equity firm really has its act together when it comes to digital marketing and it can apply those resources across its portfolio. So whether it's quick service restaurants and distribution companies and so on and so forth, they've got a lot of capabilities in digital marketing inside the firm that they can apply to their portfolio companies and help them grow. You've got other private equity firms that really have tech expertise, so they can apply technical solutions to portfolio companies. Other private equity firms are really into financial engineering and so on and so forth. So there's various different flavors, but you can bring those capabilities in. Private equity firms of course help with aligning of of of employees and team members, right? So every time you do a private equity deal, they're going to focus on okay, this is the management team. This is the employees, do they have stock options? Do they have equity participation? How do we align the incentives of the actual employees with ownership? Because we're just trying to what we're trying to do here is capital appreciation. We want to make the firm more valuable. And so we want the employees to benefit and actually see a direct line of sight between the hard work that they do and the increasing value that we're creating the firm. So incentive structures are important. Private equity firms bring those sorts of expertise to the table. Um hiring, right? Thinking about like the finance function and how do you set up ERP programs. There's a lot of things that owners of middle market businesses have have never done before. And certainly you can go out and hire consultants, but when you partner with a private equity firm, they've tested this stuff across their portfolio and they have these sorts of experts on tap. Private equity firms also bring in operational expertise. They tend to bring in operational experts that are focused on your industry. They'll go out and find former CFOs and former CEOs of the large companies that dominate your industry and they'll bring them on in as experts, as operating partners, and those guys can provide additional expertise to you, the CEO of a private equity portfolio business in running your company. A lot of private equity firms operate as clubs. They'll have semianual and annual meetings where all the CEOs, CFOs, se senior management teams of their portfolio companies get together, go out for wine, have a barbecue, spend time together, compare notes on how they're growing their businesses, and trade various different resources and capabilities across the portfolios. We see this quite a bit. And while I think there's a lot of reasons to partner with private equity, there's a lot of reasons not to. And two primary ones are listen, if you want to own 100% of your business in perpetuity and don't want to take on a partner, private equity is not for you. Period. If you're okay with taking on a partner, but you really don't want to have any oversight, private equity is probably not for you as well. Because you know, you're running a middle market business now today. Uh you partner with private equity, even if you owned a significant portion of the business, 20 30 40%. Your majority partner now is going to want monthly reporting in a way that you've never had to do that before. And at bare minimum, they're going to want quarterly reporting and they're going to set up a formal board and there's going to be board meetings and there's going to be compensation committees. Some people get excited about that and they say, "Man, I can learn a lot. I've never been part of a board. I've never had all these outside directors providing a lot of expertise and guidance." Other people can't deal with it at all. So depending upon whether or not you want to remain 100% shareholder or whether or not you want any oversight on your day-to-day, that'll help you determine whether private equity is right for you. Later in this series, I'm going to talk about I'm going to give a few case studies about some things that have really worked out well. And these things don't always work out well. Sometimes things go wrong. Sometimes people partner with private equity firms, they expect to remain the CEO, and it just doesn't work out. Maybe they're not liked. Maybe the board doesn't like them. Maybe they're not happy in general and they get the boot. So, that sort of stuff happens and we're going to talk about [Music] it. As we've discussed, private equity firms make their money from capital appreciation. Meaning, the smaller the amount they pay you, the more money they ultimately make. Which is why private equity firms live on proprietary deal flow. They love it. And what I mean by proprietary deal flow is those emails that find their way into your inbox that say, "Hey, Brian, this is Sam from XYZ private equity firm. We've been looking at your industry. We love your company and all the accolades you've had. We'd love to come out and sit down with you and take you out to wine, da da da da da, and have an opportunity to talk to you about doing business with you." That's an example of a private equity firm attempting to generate proprietary deal flow. I being a sellside banker bring a ton of private equity firms into processes. Now they participate in those processes but at the end of the day if they had their brothers they wouldn't if they didn't need to. They would only go direct to sellers because they find themselves in the absolute best position to pay as little as possible when they deal directly with you. Now in today's session I'm not going to talk about a lot of things you shouldn't do. I'm going to focus on the things that you should do as you start to consider doing a transaction with private equity. I always tell my clients. The first thing that you need to do is ultimately understand what your ideal vision for this is. I'll have a lot of clients that come to me and say, "Paul, I just want the best price for my business. I don't care who buys it. I want the best price in terms. Let's go out to process." Those guys are easy. I'm chasing a number. I take the business out to market. I run a formal process. We jack up the price. We get the deal done. I don't care if it's a strategic buyer. I don't care if it's uh a private equity firm. I don't care if it's Ronald McDonald himself. Whoever is willing to pay us the most money for that business gets it. There's a little bit of a nuance, however, when a client comes to me and says, "Hey, um, I was thinking about holding this business for another 5 years, but there's a lot of private equity activity in the industry. I've been getting inbounds all the time. Maybe I want to explore doing a deal with private equity. You know, I figure my business is worth $100 million. Maybe I want to take 50 or 60 million off the table today, roll some equity, and take another exit at some point down in future. In situations like that, I basically tell my client, listen, let's figure out then what your ideal situation is. let's craft what it is that we want and then let's go out into the market, hunt for the right private equity firms as opposed to just listening to the private equity firms that have sent emails over. I know it's it's pretty easy when over the last 2 years you've collected 50 different emails from private equity firms that are interested in your industry. And while there might be a lot of great buyers in there, I think we do ourselves a disservice if we don't sit back and think about what it is that we actually want and then go out and try to find it. And that might not necessarily be the private equity firms that are in your inbox. And I'll give you an example of that. I once had a client who just like you was getting inbounds every week from private equity firms who are interested in buying your firm, like to sit down, like to make you an offer, send us financials, we'll send you NDA, so on and so forth. But my client came to me and said, 'Hey, listen. I really want a firm that's probably going to hold this for closer to 10 years than two or three. Um, I don't want to go from one private equity firm and be flipped to another one. So, I've got a longer duration. Um, and there's some nuances of what he wanted to do with employees. So he put together a formal plan and instead of just dealing with the private equity firms that were in the inbox, now granted, we did deal with them, but they weren't the ultimate buyer, we actually went out into the market and specifically told the private equity firms what it is that we wanted and we allowed them to bid based on that. It was a much narrower private equity buyer pool, but at the end of the day, he got the exact deal that he wanted because we took control. We weren't reactive. We were very proactive and a lot of sellers make the mistake of they deal with a private equity firm or two they believe that price is objective. Everyone's going to effectively pay the same price. The private equity firms themselves are somewhat similar which they're not actually. They're very different. So our client was able to really get a sense of the types of deals that these private equity firms had done before. He talked to a lot of former portfolio companies and individuals that sold to these companies. He really got a good feel for how he would be treated, the assessment process, the governance process, the reviews process, so on and so forth. Got comfortable. We struck a deal that made him very happy. The private equity firm now, this was what, 3 years ago. I think they've more than doubled the size of that business. As a matter of fact, he wanted to hold this thing for 10 years. They've doubled it now. And most recently, they're going to go for another they're going to try to grow it another 50%. He's like, man, if we could hit that number, then I definitely want out. I didn't even think it was possible for us to grow as large as we have and for my equity stake, my rolled equity stake to be worth what it is. I don't want to hang out for 10 years. I'd rather take that cash, be done, invest in other things, and move on with my life. So, that's a very deliberate, thoughtful aspect of trying to deal with private equity as opposed to just fielding the um the emails you get in your inbox. But every one of you will get these emails. And so I always tell our clients, hold them, put them in a folder. When it comes time to run a process, we'll pull those out. We'll make sure they're included in a buyer pool. uh when we go out to market the process that you should deal with a private equity firm is as I discussed in the sellside master classes if you're going to mold perceptions from the get- go it doesn't make a whole lot of sense for you to start sitting down with private equity firms because quite frankly any sort of meeting any sort of overture like that is the beginning of the negotiation like you wouldn't sit down with these guys if you didn't want something from them. You're not sitting down with them because of their good looks, for example. You actually want to learn something. You might have some interest and you're giving them an opportunity to seduce you. I don't tell clients to never do that. I just say, don't waste a lot of time. I feel like you as the seller always want to be in control. You want to be control in control of setting up the meetings. You want to be in control of bringing in the private equity firms to sit down with you and not wasting time hanging out with these guys with a bunch of dudes. invest with the big Starbucks cops talking to you about Princeton and Yale and blah blah blah blah, it's a waste of time. You need to get smart on what it is that you want to do with your business and take control. So when you ultimately decide you want to explore the market, whether you want to do a 100% change of control or whether you want to do a maybe a majority stake situation where you're taking 70% off the table and rolling 30, you start to think through what sort of private equity partner do I want to have? What do I want my life to be like? Do I want to be CEO of this business going forward or am I comfortable having an operating partner come in and take over for me? What do you want to do? A lot of you will say, "Well, man, if I were going to be doing my day-to-day as I am now, why would I even partner? Like, I'll just keep doing what I'm doing and sell in the future." And that's a valid that's a valid position to take. Some of you say, "I I don't do much now. If I partner with a private equity firm, would I have to do a lot more?" Well, typically in my experience, you won't have to do much more than you already do on a day-to-day basis today. When you partner with a private equity firm, you know, especially founders, uh, private equity firms love to partner with founders. They like to be in a position to say, "We're a founder organization. We partner with founders." And founders are often figureheads and mouthpieces. And so, often times, you won't have to do a lot more, but there are cases where you will have to do more. And so it's important to think about upfront what you're willing to do and what you're not and actually start to put together a list to help your advisor really think through what the appropriate pool looks like. What sort of capabilities does your business have and what sort of capabilities do you need? What do you need in a partner? I mean a lot of people just go into this and say, "Yeah, I want the cash." Well, no. I mean, if you're rolling equity, what other capabilities would really help you grow this business? with supplier relationships, with marketing expertise, with financial expertise, what are the various different ingredients that a sophisticated financial sponsor can come in and add to your company and allow it to really blow up. So again, when I sit down with my clients, I say, "We're going to model this out." I I I go back to my American Capital days and I think to myself, okay, I've got company A here right now. Today, my client, company A, is considering partnering with a private equity firm, and it's a hund00 million transaction. What sort of capabilities and levers could be pulled over the course of the next 5 years to dramatically increase the value of the business and put a ton of money into my client's pocket? And by doing that exercise with the client and working through the private equity playbook with the client, the client can really understand the leverage that the private equity firm can pull, what sort of capabilities they can bring in. And now we've got a roadmap for financial sponsors. Now when we sit down with private equity firms, we're not just saying, "Hey, here's company A, B, and C. You know, we want to sell 80% of it. What can you do for us now?" We're like, "Hey, here's where we are today, and here's what this business is going to be worth 5 years from now if we can do X, Y, and Z. are you the right private equity firm to help us get there? Can you bring these capabilities in addition to the capital in order to help us arrive? And if so, what would it take from us? And it allows us to very quickly whittle the playing field down from 200 private equity firms to like 20 in a matter of weeks. And now we're dealing with 20 very high quality private equity firms that we might potentially want to transact with. And we're running a full process and we're getting the price up skyhigh. And now we're in a very good position. So I think if you're a seller and again and you're getting these inbounds in your email, you really need to think about this and you should ask yourself, how could I take control of this? Like why am I the guy that's like I don't know when you're sitting at home and somebody calls you up and says, "Hey, do you need new insurance?" You're like, "Sure, sure, I'll buy it." "Hey, do you need a new cover for your pool?" "Sure, send it out." No, you actually get out there and say, "What's the right product for me? I'm going to research products. I'm going to review things. I'm going to talk to my neighbors. So, I'm going to think about what it is that I want and then I'm going to go out and buy it myself as opposed to just buying whatever the telemarketer sells you. So, I just want you to always be in that mindset when you're thinking about private [Music] equity. Now, in both of the sellside master classes, I talked specifically about running a formal cellside process. So, I'm not going to go into all the details today, but here's one of the things I will say specifically when you're dealing with private equity. Now that you've come up with your own game plan, you've kind of determined what your business is worth today, what your business might be worth in 5 years, if you can apply all these different levers to the business, now you're able to start sitting down with private equity firms in a process. And for me, a private equity process is slightly different than a broad process when you're dealing with both private equity firms and strategic acquirers. The more you know what you want to do, the more you're going to be in control and the better off you're going to be. And here's what I mean by that. When you whittle that playing field down from 200 private equity firms to 20. Now you can bring these guys in and instead of them interviewing you, now you're interviewing them. Now you're sitting these guys down and they're using the douchebag playbook and telling you about, you know, bites of the apple and turns of this and blah blah blah blah blah. telling you all about their Ivy League schools that they went to and how they interned at Goldman Sachs and all this that you don't care about. Now, you're going to be able to say, "Okay, private equity firm, I I want to know specifically what you've done on all these various different portfolio companies that you've already researched because they're on their website. So, you've read about every portfolio company. You know the individuals that actually did the deals with the private equity firm. You're going to talk to them about what sort of capabilities did they bring to the table? what were the returns on those investments? Who was on the board from the private equity firm at those companies? What sort of changes in the business? You're going to be able to get into a tremendous amount of detail and have them walk you through specifically what they were able to do to create value. Because at the end of the day, money is fungeable, right? Meaning anyone can come up with capital. You don't need a sophisticated private equity firm to do that. But what private equity firms do in addition to that is they bring a lot of various capabilities to your firm and hey listen this is a job interview baby. I want to know what you can do for me. And I love when clients actually take that approach. I love when clients sit there as opposed to being just very reactionary passive and like I think I want to sell my business and I'm not quite sure. What can you do for me? And that no this is what I want to do. Are you the right party to help me do that? Yes or no? And if you're not let's not waste any more time. Now, I'm not saying you need to be a dick about it, and as I say in my Southside master classes, I think you need to be playful and you need to be friendly and you need to be fun. But you're on a mission, and you have to remember that because you will waste a lot of time. There are thousands of private equity firms. You'll waste a tremendous amount of time on the one hand. And on the other hand, if you just answer the telemarketer who's like, "Hey, pool covers private equity," then you're going to end up leaving a ton of money on the table. You don't want to do that either. Again, you want to take control of the process. And when you're doing a private equity deal, again, the right way is you go through this process, you're going to get indications of interest. Like the private equity firms are going to say, "Hey, Michael, I love your business. You know, here's what we would do with it. You know, we'll pay between X and Y. Here's how we structure the deal. You're going to roll, you know, 15% of the purchase price. We're going to keep you on. We're keep your right-hand man on. Um, here are the things that we intend to do with the business. We enjoyed our conversation. We talked about all these different levers we can pull. Here's what we'd do. Here's how we'd structure it. We'd love your opinion on our proposal. And so you'll get a handful of these, you know, ideally you'll get 20 of them, right? And so you've got a lot and you can lay them all out on the table simultaneously. You're going to say, "Oh, this one's a piece of and this one's crap, but this one, I like these. I like the purchase price. I like what they have to say. Now we're cooking with gas. Now we can start a process." When you're contemplating a control situation, when you're contemplating a private equity firm buying a majority stake in a business, a control process works quite well. When you're doing a minority interest in a business, when you're going to do a growth equity investment, a control process sucks actually. And I would largely advise people not to use formal processes when you're taking on a 20% equity partner. I mean, you're not giving up a ton of equity. So, I mean, you don't have to extract every nickel off the table here. Um, and what you're doing is you're forming a partnership with a minority investor. It's really a partnership based on some capital as well as some capabilities. Whereas, when it's a control situation, I mean, the majority of your your business is being transacted for, right? So, you want to make sure that you get every penny you can squeeze it all out. Uh, you want to make sure that the deal is structured appropriately, and we'll talk about that. So once you run this thing through an iterative process and again I'm not going to belabor that because I talked about it extensively in the sellside master classes now you find yourself with a whittleled playing field of one two three private equity firms and you might be faced with a variety of different options. One private equity firm might say hey we love your industry Michael like we're all in on this and you're going to be our platform and this is going to be our brand name and we're going to do all these acquisitions and we're going to make you the CEO and you're feeling great. I'm getting all this money I'm going to be CEO this is fantastic. That might be an interesting opportunity for you, but you might have a ton of work to do. I don't know. Then, Michael, you might have another situation. You might have a private equity firm that says, "Hey, listen. We're looking at two businesses in your industry, Michael. Um, one's a little bit bigger. It's got a better brand name. So, we're going to combine those two. We're kind of working on the other one now. We want to do it simultaneously. Um, so we will use your business, but you can kind of stick around. We definitely need you to roll equity, but you're not going to be the CEO." When you look at it in the economic terms are right, that might be a better situation for you. Just last week, I closed a transaction with Digitalist Capital where they combined three fire protection companies like on the first deal and uh they used one of the brands, combined three of them. One of them was our client and the client was super happy with the way it went down. So, you'll find different flavors as you deal with private equity firms. What I'm trying to impress upon you is every one of them is different. Every one of them may be contemplating different deals. Every one of them will have different ways in which they operate. Some are lower middle market private equity firms, right? They're only going to build a hund00 million business. Some are kind of middle market or upper middle market. They're going to buy a build a 500 million or a billion dollar business. And so what sort of deep pockets does the private equity firm have? Are you dealing with somebody that has 500 million under assets under management or two billion? Right? And so there's those sorts of considerations and um I think it allows you to really understand what sort of runway you're going to have. So again, I think the broad process of taking a lot of private equity firms meeting the lower middle market, the upper middle market, where you're going to be a platform, where you're going to be a tuckin, where doing those sorts of things gives you some optionality, but at the end of the day, you're the one creating the vision. I I I I want you to really think about this like you need to be the one creating the vision for this business. You shouldn't be passive. Now your vision can change, right? Your vision can change, but I think setting the vision for yourself is something like structuring boundaries where the other party is going to very quickly self- select like do I want to do business with Michael? Like he's got this grandiose plan and he wants a financial sponsor that looks like this. That's not us. Well, that's great. That's great. You you just got valuable information. that's not the right party. Don't waste time on them because I can promise you there's scores of other private equity firms that'll fill right in where they've left. Don't fear offending any of these guys. Don't feel like you're cut them out of the process because they're a dime a dozen. Okay. So, now you've gone through this and let's say that you and I don't know who Michael is, but we're going to use him today. Michael, I appreciate your assistance. So, Michael, you now have chosen the private equity firm that is going to put your face on the mug, so to speak, right? You're going to be the big daddy, the CEO. They're using your brand. You're the platform. And you've done a great job because you've in in your Southside materials as you were going through this process, you sat down with me and you said, "Paul, there are seven or eight companies I want to acquire." And I've met with all of these guys. I know Jim and I know Bob and I know Helen and I know their kids and I know what they're do, what they do. I know how they fit into our business. I kind of have a sense of what I would have to do in order to be able to buy them. So, I've got my acquisition pipeline. You've got your financial plan. You've got your systems plan set up from a tech perspective. You're like, I need to revamp this tech system. It's going to shave a few basis points off our cost. You've got this plan all put together. The private equity firms loved it. They're giving you a great price. Now, the deal's actually about to start. Right now, we're at ground zero effectively. Now, we're going to sign a letter of intent. And the letter of intent, I think, is important um with private equity firms and sometimes more important because, you know, in any industry, when you're dealing with a strategic acquire and what I mean by a strategic acquirer is an acquire that might be a publicly traded company or a large privately held business within your industry. They're very well known in the industry that you operate in. And if they're serial acquirers, meaning they go out and buy a lot of businesses, have done so for a long time. They are particularly concerned about the reputation. They don't want to be the company that goes out and buys a company and shits all over it and then gets a bad reputation, then no one else wants to do a deal with them. So, they tend to be pretty careful. They tend to be more sophisticated on the I shouldn't even use the word sophisticated. They tend to be more cautious on the front end when they sign letters of intent and they want to make sure they anticipate what they might find in diligence. They're also familiar with your industry, so they can ask you a lot of questions that sometimes private equity firms can't because they actually know what you do intimately, and so they can sus out problems usually on the front end of signing a letter of intent. Private equity firms don't, however, unless they have a tremendous amount of experience in your industry. What a private equity firm will often do is bring on outside experts. They'll sign a letter of intent and then their diligence process is often extensive. They're going to bring in outside industry experts. They're going to bring in large accounting firms to do transaction services, quality of earnings reports. They will bring in a lot of consultants. And you know, private equity firms will spend hundreds of thousands if not millions of dollars on due diligence, which is a multi-month process. And I think one of the things you should be concerned with if you're a seller about to sign with a private equity firm is if this is a new industry for them, they are probably going to learn a lot not only about your business, but about the industry after they sign the letter of intent. And you might be at risk for a retrade. And what's a retrade? A retrade is I'm giving you $100 million for your business. sign this letter of intent. You say, "Fine, I'll sign the letter of intent." You sign the letter of intent. Now, I start doing all this diligence and I'm like, "Yeah, you know, I didn't really realize how these widgets were made. It doesn't I mean, like I don't know if we're going to be able to do exactly what we want because and you're like, well, that's how widgets are made." And I'm just I didn't know that. I got this expert guy over telling me that widgets are made differently and I'm not quite sure. So, I think we're going to have to make a new widget conveyor belt, which is going to cost us money. And so, I'm going to ding you on the purchase price. Congratulations. It's now a $90 million deal. And so, you're violently upset because you're like, this private equity firm, these guys are morons. They've never run a business in their life. And the private equity firm's like, I don't know. We're talking to these experts out there and they're telling us that you're not right. And so you end up running into these sorts of things with private equity far more than you do with strategics, which is why I'm going to say it publicly. I'm always a little bit more nervous when private equity is very heavy for me in a process, especially private equity that does not have experience in the particular industry I'm dealing with because I know the incidence of a retrade could be dramatically higher than if I'm dealing with a an experienced private equity firm or a strategic. So, I just want you to make a little mental note of that as we walk through this [Music] process. So, you thought it through. You're ready. You're excited. You're going to be the private equity kingpin. You have your name on the building. You're going to be the king of the platform. You're going to take 70 million in cash up front, roll 30 million. You say, "Paul, I want to sign this LOI. Let's negotiate it." Now, DD is right around the corner. The due diligence phase as soon as we negotiate and sign this letter of intent is going to make you reminisce of your last digital prostate exam fondly because it ain't going to be fun. But we take out the LOI and we're going to mark it up and do our final negotiations. And the LOIs from these private equity firms are pretty typical. Dear Michael, we had a wonderful time with you at Rick's Shrimp and Grit Tavern by the Lake. You've really built something special. We're so excited to partner with you. Michael, you're not special. This girl says this to all the guys. So, quit reading this nonsense and let's get to the actual terms. Let's look at the indemnification, the survival of reps and warranties. Let's look at the term, the equity participation agreement, what it says about the purchase agreement. Oh, there's a 3x liquidating preference in here. If things go south, you're going to be lucky to be a greeter at Walmart, right? So, we negotiate the letter of intent. We ultimately sign it. Now, at some point in a future episode, I will go through deal terms uh in excruciating detail. It's too much for today. So, we've signed the letter of intent, we start due diligence. And from a private equity perspective, due diligence can sometimes be a little bit more complicated than a strategic. You know, a strategic acquire in your industry again will understand your business. They know the shortorthhand. Um, again, they don't need to know exactly how the widgets are made, per se, because they're in the widget business and they get that. But the private equity guys will of course like to hire outside experts and unfortunately they're going to end up hiring a lot of people who you think are buffoons. Uh people who can't keep jobs elsewhere. A lot of in my own personal experience like a lot of the operating partners at these private equity firms are guys that literally can't be employed in the industry. So they're always looking for a job and somebody refers them to this private equity firm. They're like, "Oh, I'm a private equity operating partner." It's like, "Yeah, you couldn't keep a job anywhere else. Here you are." But getting back to what we were saying, they will do operational diligence using outside consultants, people that you likely know and dislike. They will uh do financial due diligence and accounting due diligence. So, they're going to bring in a large accounting firm that's going to be a total pain in your ass, which is why we're going to spend a lot of time on the front end making sure your numbers are ship shape before you even get into exclusivity. Because once you sign that letter of intent, we've got to say to the rest of the buyers, bye-bye. We're dealing only with one party until we get to the closing. And the due diligence period might be anywhere from 30 to 90 days roughly. So, they're doing operating diligence. They're doing financial and accounting. And financial and accounting due diligence again is the outside accounting firm looking through general ledgers. They want downloads of your Peach Tree, QuickBooks, Sage, whatever you're using. They're looking through past audits if you have that sort of stuff. They've got tax due diligence, right? They're also do due diligence on title. Do you actually own the assets that you're selling? So, there's a lot of operational, financial, and accounting due diligence work streams. Um, and then they're sitting down talking about the acquisition opportunities that you have, like, okay, when can we buy these add-on acquisitions that you brought up in our meeting at Rick's Shrimp and Grip Tavern? Um, diligence is painful. It is very painful and it's really good to be prepared for that on the front end. And one of the ways that you can do that is you could do a sellside vendor DD data pack. You could hire an accounting firm yourself to get your financials in order. Typically for us over here at PTOIC, we have our own transaction advisory team inhouse and I make sure my team goes through that to see if it passes muster before we actually get into DD with any acquirer. And we don't do the sellside data packs because we're actually advising on the transaction. We'd need a third party to do that, but we at least get it to the point where we know for sure whether or not our client needs it. And I would say probably once per year, we send somebody off to bring on an outside accounting firm to help them get prepared for financial and accounting due diligence. But as you're going through the documentation and the diligence phase, you're drafting the purchase agreement and the equity participation agreement. in the purchase agreement. It might be an asset purchase. It might be a stock purchase. It depends on how the transaction is structured, but you've got your legal counsel working along in conjunction with us on drafting the legal documentation. You're drafting the equity participation agreement because again, now we're going to be a partner with this private equity firm. So, there's a shareholder agreement that you're going to sign and that's going to explain your rights and obligations as a shareholder. you know, document review, when you can see financial statements, what happens if things go south, for example. So, those are really important documents to spend a lot of time on. But at the end of the day, you ideally get to the end of DD with no red flags, no retrading, no purchase price adjustments. The documentation largely matches what was described in the LOI from a terms perspective and you close. And I am happy to report at least on advisor deals, I mean I'm talking specifically about ours, but I know a lot of other great advisors that have extremely high success rates in getting these things across the table. So if you've got the right sellside adviser and you've got the right legal team and you've got the right finance and accounting team helping you, it's going to be painful, but you'll get there. Now you get to the closing table. Documents are signed. It's now virtual. People don't sit around tables anymore and do this. Signature pages are exchanged electronically. The transactions consummated. You've got $70 million in your bank account. And now you are the proud owner of 30% of Newco. And you take on your new role as CEO. And usually often times with private equity firms, they tend to have maybe 100 day plans or three-month plans where they're getting you acclimated to what it's going to be like working with the financial sponsor. getting you acclimated to what the board meetings are going to look like, what sort of reporting you're going to have to do, who you're ultimately going to report to, and ideally, if you played your cards right, you figured out a lot of this pre-ali and in the diligence phase, so by the time the transaction closes, you're ready to hit the ground running and there's no misunderstandings as to what you will or won't be doing going forward. And as we discussed prior, you know, now the goal here is asset appreciation. What the private equity firm is going to attempt to do is 2x or 3x your business in as short as a time period as possible, which will ultimately allow them to exit. And what their exit looks like, I mean, if you're a middle market business, you're probably not going public. So, you'll ultimately be sold to a strategic acquirer in your industry or a larger private equity firm at some point in the future. If you're a mediumsiz firm, going public might in fact be an option. But in those kind of two to seven years that you have as a partner with a private equity firm, you're probably going to be doing everything from maybe bringing in a new CFO, bringing in a new CTO, a CMO. You're going to be hobnobbing with other members of the portfolio, other CEOs in the portfolio company, understanding how they've been growing their business. You're probably going to restructure the cap structure of your business, meaning you might take on some additional debt. They might take out some equity. There's a lot of financial engineering that might go on there. Um, but overall, you will likely have a great partner that'll provide you a lot of flexibility and a lot of ability to grow your own business in your own way. And when I think about private equity firms, you know, I probably do somewhere around 20 of them per year. And some of the firms will come in and you know I I had a client we did a deal two years ago and he's like I barely even realize these guys are there. I mean they have such trust and faith in me and my team. Yeah. We send them monthly reports. We have quarterly board meetings. That's about all I hear from them. They look at our numbers. We're performing. I don't hear much. If I need something from them, I can track them down and they'll help me. But for the most part, it's kind of business as usual. Other guys will say, "No, these folks are actively involved in our business. They get on a plane, they fly out sometimes every other month. They want to check on things. They want to talk to us about strategy. They're bringing on additional folks to help us. Some people like that, some people don't. Understanding the pedigree of the private equity firm that you want to deal with, I think, will go a long way in helping you understand whether or not that's the right partner. And quite frankly, an easy way to do that is just pick up the phone and talk to the CEOs of the portfolio companies that they've already partnered with and ask questions like, "Hey, what's it like to work with these guys? Did they try to retrade on you when you were doing the deal or did they close on the terms they promised? What's it like on a month-to-month basis? Are those guys a pain in the ass?" So, you can have these very informal conversations to educate yourself. And in fact, I mandated to my clients, you know, we whittle down the playing field and we're down to like two or three financial sponsors. I'll tell the clients, hey, let me get a list of people. Let's get online. Let's research all the portfolio companies. Let's see who they don't give us. Right? If we got 10 portfolio companies, they only give us three names. I want to talk to the other seven. The companies they've already exited. What sort of returns did these guys get? What sort of problems they have? So, you know, if you want to take this seriously, you can have a lot of conversations and acquire a lot of data points that will really help you differentiate between various different private equity firms you're dealing [Music] with. Now, I wanted to take this time to talk a little bit about some of the misconceptions I think I hear quite often. A lot of business owners think that private equity firms will come in and terrorize the company and lay off all the people and strip it. Uh, in my experience, that's really not been the case. I mean, maybe we saw this take place quite a bit back in the 1980s, but right now, private equity firms are acutely focused on growing these businesses. So, you don't often see a lot of layoffs. Um, you'll see some things that I think business owners are typically uncomfortable with. You know, a lot of private equity firms will come in and raise pricing. I think that's pretty prolific. Private equity firms will be looking at pricing and due diligence and understanding how you price your products and services. And they might have their own ideas. They might bring in pricing consultants. So, after the deal closes, they might focus on raising prices. And quite frankly, a lot of you need to raise prices. So I I don't think you should fear them canning a lot of people. I don't think you should fear them messing up the business, but there will be changes. They are going to do things differently. They might centralize some things that you haven't centralized historically. They may take a hard look at some of the employees you have. You know, a lot of small and midsize businesses engage in nepotism, right? They're quote unquote family businesses. A lot of you have employees that should have been fired a long time ago. You know, George, he's 82. You've kept him around because he knew your father. You don't have the heart to let him go. Well, you know, might be time to let him go. It might be time to replace him with somebody who's full of piss and vinegar that's going to help you grow the business. So, there will be a lot of those sorts of discussions with private equity, which I think are quite frankly welcome because they're focused on growing this business, and you should be, too. So, there will be some oversight there. But for the most part, I can tell you the majority of our clients that have gone through and done a majority buyout with private equity have done quite [Music] well. You know, to recap here, private equity firms take capital, they pull it, they invest it in the private capital market. So, they make investments in privately held businesses, which is a very opaque and fragmented market. Private equity firms will typically be buying either a majority or controlling interest in a business or sometimes they take a minority interest or a growth equity investment in a company. Those are the two broad classifications of private equity firms. Private equity firms can be generalists or they can be specialists. They can be opportunistic the way they go out and will buy anything as long as they can get it at the right price. Or they will be thematic. They'll choose specific industries or sectors that they're going to focus on and they're going to consolidate that particular industry. Private equity can work for you as a potential business seller. Even if you want to sell 100% of your business, they're often times some of the bigger payers out there. They're ideally suited for individuals who actually want to bring on additional resources and capabilities who want to have a strong financial partner that's done things that they haven't done. And in exchange for that, they're able to not only take some capital out of the business or get a little bit of liquidity today, they're able to co-invest with very sophisticated operators going forward and ideally have a much bigger exit in the future. So that's an opportunity for individuals who really want to grow their business. Co-investing along with private equity can be exciting for a lot of folks and it's extremely prolific today. I mean I think the number of private equitybacked companies in the United States is like 25 times that of publicly traded companies. From a valuation perspective it's much smaller than the public equity markets. But as far as the number of private equity backed companies, I mean it's mindboggling how many there are. So this opportunity might make sense for you. However, transacting with private equity, just like everything else, the devil's in the details. I think one of the most important takeaways from this discussion today is that you should take control of your own process when it comes to private equity. You should be the one determining what you want and setting the boundaries. Don't take a passive approach and let somebody do that for you. So, I want you to be very active in making decisions as to what you want and then hunting and going out and finding the right partner, not sitting back waiting for the telemarketer to sell you pool covers or private equity financing. Right? Take control of it. The sellside process is an important way for you to extract as much value as you can from a transaction. So, never ever, and you certainly don't have to use us, use somebody who is a sophisticated adviser who's going to run a competitive process for you. Please don't respond to an email and do a deal with the first private equity firm that tracks you down. That is a great way to put money in their pocket which came directly out of yours. In our practice here at PTOAC, I would say probably 50% of the transactions that we do with private equity are guys who literally have been approached from that unsolicited email, decided to sit down with a private equity firm. They took the slow mating dance and then before you know it, there's an LOI written. And now the seller looks at it and says, "Well, man, I don't know if I'm getting a great deal or I'm getting totally screwed." Then we get the call. So, if Private Equity's reached out to you, feel free to reach out to me. You can contact me on the contact form below in the description as well as you can always reach me on LinkedIn. I'm Paul Gammore. Thanks for joining me today. I'll see you on the next one. [Music] [Music] [Music] [Music]