MARCH 2014 Issue
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The Evolution of Private Equity

Doug Robbins

Private Equity Groups (PEGs) really started to grow during the early nineties, and as of June 2013, there were 2,797 Private Equity Groups operating in the United States owning 17,477 businesses, and employing over 7.5 million people.*

PEGs are really an American Phenomenon: of the top 50 PEGs in the world, 34 are US Based, and of 255 significant PEGs worldwide, 190 are US based, and only 4 were Canadian.

*WikipediA


 

Investing organizations, such as pension funds, private foundations, municipal governments, etc. have to invest their monies in order to achieve their various missions.  Traditionally they invested

in the public stock markets, mortgage funds, bonds, large projects and sometimes in larger private companies.

 

As an Intermediary, I met my first PEGs in the mid-eighties and at that time and well into the nineties, found that they were all pretty much the same, looking for:

  • Low-tech manufacturing businesses
  • Non union
  • EBITDA's of 2 to 10 million,
  • Great growth opportunities
  • Management to stay

Concurrently, as time evolved, discontent grew with publically traded companies by those investing becoming frustrated with:

  • The lack of input or control in business investments,
  • Remuneration programs for senior executives and directors, and
  • The lack of input into overall direction of the companies they had invested in.

It is also important to recognize that taking a company public is now a very expensive process and the annual compliance costs are enormous.  The result is that the public arena is no longer a place for the owner of a small or medium sized company to go to look for growth capital.

It is interesting to note that today; there are fewer publically traded companies than there were at the turn of the century, only 14 years ago.

We all know that the banks can be frustrating to say the least, and often are of little help, without personal guarantees, outside collateral support, a mortgage on the family home, a spouse's guarantee, or outside support such as government guarantees (SBA).

Capital to grow a business can be elusive:

  • going public is not an option
  • banking sources may not be of much help
  • FFF sources are difficult to manage (Fools, Family & Friends)
  • partnerships have short life expectations and can be difficult,
  • many great opportunities are missed because internal funding can be painfully slow.

So where one should go if one wants to grow his/her business and needs capital?

The PEGs are providing a vehicle for the investors to have greater input into the operations of the businesses they are investing, and are becoming the new source of capital for the mid-sized businesses.

PEGs now come in all kinds of shapes, sizes, investment criteria, business interests, specialization, etc.

Some look for:  Large companies, others medium companies or small companies

  • many want 100% control

others more than 51%

now there are a number of them who are content with less than 51%

  • some focus on geography

others on product or service

others on roll-ups

some specialize in funding growth

  • some do recapitalizations to:

take money off the table for owners, leaving them to operate

fund management buyouts

fund intergenerational transfers

  • most want profitable companies 

but some will do turnarounds

  • most leverage their capital with debt
  • some have 'sunset provisions' usually 5 to 7 years

others are in for the longer term

some never sell their holdings

  • some are well funded, and have lots to money to invest (dry powder)

others are unsponsored and look for investors on a deal by deal basis

and still others are family owned and controlled

 

Something to keep in mind,a business needs three things to be successful:

1.       A product or service

2.       Competent management, and

3.       Capital-both debt and equity

 

PEGs are formed by securing a commitment from a funding source(s) and are similar to mutual funds that invest into specific kinds of public companies. The PEG invests into a particular class of business that meets the funding source's objectives.  The investors look to the PEG for business acumen, competence, knowledge in a specific sector, management style and skills. The PEGs charge an annual 'service' fee to manage the investment, and to oversee the company in which the money is invested.  Their fees usually include a bonus based on the eventual growth in the overall value of the investment.

Generally the 'funds' are to be repatriated in seven years (the sunset period) and  they would began to think about selling their investments in about 5 years with most funds to be fully repaid in nine years.

While banks are pretty much the same, due to process and regulation, PEGs now come in many styles, shapes and colors, and one size no longer fits all.  Finding the right PEG is probably the most frustrating part of the process.              

One of the newest PEG offerings/services is recapitalization programs.

 

We just completed a transaction:

o                 Revenues     $12,500,000

o                EBITDA:        $2,500,000

o               Contracts pending to increase revenue by $10,000,000 annually and increasing EBITDA TO $6,000,000

o               Capital cost for equipment, training, & additional spaces about $6,000,000

o                Client said no to bank financing .... Heavy restraints, fast repayment of debt, personal covenants, mortgage on family home and cottage, spouse's guarantee.

o               The owner decided to stay his current size and pass on the growth opportunity.

 

Along came a PEG and who offered to:

o                Buy the company for $10,000,000

o               Give the client a 25% stake in the new company

o               Offered to pay him a salary of $200,000 per year, plus performance bonuses (and let's not forget the 25% equity kicker)

o              Arrange the necessary capital to expand the facilities to handle the new business

o              No personal guarantees

 

This was a happy outcome for both the PEG and the client.

 

There are as many variations to this model as there are blades of grass in your front yard; with each situation being unique; and each transaction structured to meet the needs and aspirations of all the parties.

Today, money is quite plentiful to the point it is becoming a commodity, and the PEGs are becoming a conduit to that money. What is the typical PEG looking for? Only two things:

  • A product or service that is in demand, that generates a profit, with potential to grow, and
  • Competent management

PEGs have become a major force in the acquisition and investment arena, and if you are looking to sell or transition your business, I would strongly suggest that serious consideration should be given to working with a PEG.

D.M.(Doug) Robbins

President  & Founder

                                                                                                                  Robbinex Inc. 

Since 1974

 

More information:

http://www.pegcc.org/education/fact-and-fiction/