The Private Equity Survival Guide: How to Win Before You Sell | An M&A Masterclass

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 Selim Bassoul, the CEO of Middleby 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 Middleby on the northwest side of Chicago.

Selim was there to demonstrate the power of Middleby’s technology and to discuss with us the proposed acquisition of Blodgett. At the time, I was an analyst at American Capital, the largest publicly traded private equity firm in the United States, and Selim 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 Middleby oven.

Middleby was on the verge of something big. They weren’t simply satisfied with making the best of it. They wanted to be the undisputed leader. But in order to do that, they needed more than innovation. They needed capital. And 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.

I am Paul Giannamore. I’m an investment banker, and I negotiate for a living. Today we’re gonna 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 pool capital and they invest it largely in privately held businesses.

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 gonna 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% and a hundred percent of a business. They wanna 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, 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.”

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 about 10 years as the average. That general partnership will put capital in, sometimes 5%, sometimes 10% of the total amount expected to be raised. And then the practitioners, 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’re 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 hundred-million-dollar fund. You’ve gone out, you’ve raised a hundred million. I’m your investor. I say, “I’m gonna 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 gonna 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 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. Private equity firms get their returns kind of in the same way that you, a business owner, would get a return from your business: capital appreciation and dividends. For a business, that’s capital appreciation and dividends; for private equity, it’s capital appreciation and a 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 two, three, 4%. And in the industry over the years, we’ve typically heard about two 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 hundred-million-dollar fund. It raises a hundred million dollars 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 that $10 million business in year one, and in year seven it exits, and that business is a $30 million business at that point in time. The capital appreciation — the 10 million that we started with 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 taken over time. And later in this series, I’m gonna talk a little bit about management fees, and I’m gonna 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 let’s say, for example, they 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’re partnering, pari passu, with you. We’re not taking a management fee ’cause we’re partners.” Other private equity firms will take a straight 20% carry, straight 20% 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.
Now, in the previous example that I gave you about American Capital’s investment in Middleby — 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 dot-com bust. We were immediately after the terror attacks of 9/11. So the capital markets were particularly difficult to tap, and that’s where private equity stepped up.
You know, banks weren’t interested in lending. Middleby wanted to make the acquisition of Blodgett. 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 Middleby.

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 Middleby, it was a minority stake in Middleby. And American Capital provided that capital specifically for the purposes of Middleby doing the acquisition of Blodgett.
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 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 to come in and fill that gap was the only way that Middleby was gonna get that acquisition done. That’s a prime example of how private equity can step in and do a growth equity investment for a specific 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 the private equity firm, your interests typically are a hundred percent 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 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 a typical $50 million residential services business. Now it 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 not only debt capital, but also equity capital. In addition to buyout 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 and 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. We invested in Piper Aircraft, Case Logic, a toll-booth operator, a pneumatic valve manufacturer, Middleby the oven manufacturer. Whatever it was, you name it, American Capital would look at it. And 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 on, and ultimately submit proposals to the investment committees. And the investment committee would approve somewhere between one and one and a half percent 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 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 wanna 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, change strategies, involve 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 on the pneumatic valve industry, and 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 gonna focus on pneumatic valves, for example, and attempt to roll up 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 advisors would send us materials on their sell-side engagements — 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 guys 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, how the hell do I tell the difference from one private equity fund to the next? Because they all wear the same vest and drink from the same coffee cups and say the same sort of things and the same sort of buzzwords. And later in this series, I’m gonna 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 — a more opportunistic approach.

So when I worked at American Capital, I was a junior guy on the deal team. Now, 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? Where I get to go out and buy companies and invest in ’em and grow ’em and sell ’em.

And it was all cool, right? I was in my early twenties 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 was required to reach out to guys like you and say, “Hey, do you wanna sell your company? We’re super cool.” And I got materials from investment bankers, so I would weed through these.
CIMs all the time. These confidential info memos on just ridiculous shit, right? You know, a company that trucks satellites, this company makes aphrodisiacs for dogs. It was all sorts of stuff I was looking at. And I had to think about what could we — again, American Capital was an opportunistic acquirer.

So I’d look at a company that does — you know, I use pneumatic valves because we made an investment in a company called Pneumatics, and they were a pneumatic valve manufacturer. And 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 entry multiple, right? So one way of doing it was through consolidation. Another way is, 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? What sort of marketing capabilities do we have? You know, is this company doing online marketing? I mean, I don’t know how many pneumatic valves were sold online — and again, this was back in 2000, 2001 — but 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, we’ve got ownership, but no one under ownership actually had any real incentives. There were no equity option plans, there was no profit sharing, there was no phantom stock.

There’s a million different ways you can do incentive plans, but the company had none. So how could we take some equity, pool it, and then provide some incentives for key leadership there? Another question is, I mean, is this a hundred percent buyout? Is this a control buyout? Is the owner somebody we actually wanna 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 shit with pneumatic valves, that we could pull in from the outside and bring into this business to help us grow it?

Somebody that had this secret sauce that we don’t have. We would look at the strategy. And again, it’s almost ridiculous when I think about it. Here I was, like a 24-year-old kid, trying to think about 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 wanna 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, “Well, 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 that. And in the next part of this series, we’re really gonna get into deal structuring. And that’s where I’m gonna 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. 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 in private equity — private equity firms, although they talk about multiples, what they’re really looking at is internal rates of return on investment.

Now, I don’t want to get too complicated and complex in today’s discussion. 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 — the question that they’re asking themselves in the background, what they’re modeling, is this:
How much do I have to pay today for a business that’s going to be worth X in five years, based on all the things that I can do with it? So they’re gonna say, with all the different value levers that they can pull to help grow this business and create value, it’s going to be worth a hundred 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 five-year IRR of 30%, or a five-year IRR 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, say 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 transactions, statistics, so on and so forth.
But the key overarching — you know, when I would write my investment committee memos, of course the investment committee wants to know what the EBITDA and revenue multiples are in the industry, but 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 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’m gonna sell my business. I’m gonna 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 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 NewCo.

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 that ultimately sold for $75 million. And the majority of the strategics and the private equity firms, from a valuation perspective, were in the fifties and sixties.

We had one private equity firm that wanted that company as a platform and was willing to pay 75 million bucks for it. But they wanted to put $60 million down in cash and have the owner roll 15 million into NewCo. 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 gonna do that deal.” Now, that particular owner sold that business last year, took a 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, and now they’re doing add-on acquisitions. He got 60 million bucks, and now he owns 15% of NewCo. And when that private equity firm exits 3, 4, 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 three-x return on that money.

So in a perfect world, he walks away with 45-plus million dollars. 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 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 could take it to a hundred million, 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, do the types of things that I wanna do, while still maintaining control of this business.”

“I wanna be the majority shareholder. I wanna be able to call the shots. But I would like to have a partner that can help me do acquisitions, ’cause I’ve never done acquisitions before, that can help me revamp my marketing program, that can help me hire a CFO. 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. We would bring in strategics, always, because the strategics help us get an understanding of valuation and options. 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 wanna sell 70% of the business, 80% of the business, 90% of the business? You know, how much do I wanna pull out? How much will I wanna roll into NewCo? What sort of participation will I have going forward? Most of the time they want to continue to be CEO, 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 as CEO, the private equity firm backs them, allows ’em to do acquisitions, so on and so forth. Private equity deals also come in the flavors of a hundred percent 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 a platform, I mean that’s a portfolio company. You’ve got private equity firm ABC, which has a fund that invested in the 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 a hundred percent — do a hundred percent 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, and they’ve taken sizable capital off the table — 70, 80, 90%. That’s a pretty plain-vanilla deal.

We do dozens of those every year. We see those all the time. I think, from a participation perspective, when you start to think about private equity, the guy that actually has 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’ll use that interchangeably with private equity — wants to take on a private equity firm and partner with that private equity firm, 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 gonna 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 change-of-control scenarios. Now, over here at Potomac, 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.

But really, when folks take on a growth equity investment, they’re actually looking to grow. They might have a great acquisition opportunity, like Middleby acquiring Blodgett — acquire our largest competitor, right? That’s a great opportunity. They might have some AI technological investments that they wanna 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 was an extremely visible aspect of that. But there’s also a lot of other important reasons. In residential and 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 will have the aspiration of ultimately taking a business public and say, “We need to partner with a private equity firm that does this — a firm that has made a bunch of investments over the years and taken a lot of these companies public, because they’re gonna understand how to structure the board.”

“They’re gonna understand how to structure the corporate docs and governance. They’re gonna be able to bring a lot of other resources and capabilities to help us grow this. And 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 and capital for you.

The owner — they bring on additional access to capital, right? You own a hundred-million-dollar commercial services business. You can tap commercial banks, right? You can get capital, but you certainly can’t get 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 inexpensive debt might be a great thing for you in order to grow your business. So, access to capital, access to other resources and capabilities.

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 ’em 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 the aligning of employees and team members, right? So every time you do a private equity deal, they’re gonna focus on, okay, this is the management team, these are 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 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 with the firm.

So incentive structures are important. Private equity firms bring those sorts of expertise to the table. Hiring, right? Thinking about the finance function, and how do you set up ERP programs? There’s a lot of things that owners of middle-market businesses 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 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 semi-annual and annual meetings where all the CEOs, CFOs, 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 a hundred percent 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. You partner with private equity — even if you own a significant portion of the business, 20, 30, 40% —
your majority partner now is gonna want monthly reporting in a way that you’ve never had to do before. And at bare minimum, they’re gonna want quarterly. And they’re gonna set up a formal board, and there’s gonna be board meetings, and there’s gonna 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 wanna remain a hundred percent 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 gonna 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 gonna talk about 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, and 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 sell-side 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 druthers, 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.

They deal directly with you. Now, in today’s session, I’m not gonna talk about a lot of things you shouldn’t do. I’m gonna 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 and 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 a private equity firm, I don’t care if it’s Ronald McDonald himself. Whoever’s willing to pay us the most money for that business gets it. Yeah, there’s a little bit of a nuance. However, when a client comes to me and says, “Hey, I was thinking about holding this business for another five 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 a hundred million dollars. Maybe I want to take 50 or 60 million off the table today, roll some equity, and take another exit at some point down the 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 and 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 pretty easy when, over the last two 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, would like to sit down, would like to make you an offer, “Send us financials,” or, “Send you the NDA,” so on and so forth. But my client came to me and said, “Hey, listen, I really want a firm that’s probably gonna hold this for closer to 10 years than two or three.”

“I don’t want to go from one private equity firm and be flipped to another one. So I’ve got a longer duration.” And there were 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 his inbox — now, granted, we did deal with ’em, 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, that everyone’s gonna effectively pay the same price, that 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 — and got comfortable.
We struck a deal that made him very happy. The private equity firm — now, this was, what, three 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 gonna go for another. They’re gonna try to grow it another 50%.

And he’s like, “Man, if we can 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 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, pull those out.
We’ll make sure they’re included in a buyer pool when we go out to market. The way you should deal with a private equity firm is, as I discussed in the sell-side masterclasses — you’re gonna 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 wanna 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 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, not wasting time hanging out with these guys — with a bunch of dudes in vests with the big Starbucks cups 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 wanna do a hundred percent change of control, or whether you want to do 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 wanna do? A lot of you will say, “Well, man, if I were gonna 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 position to take.

Some of you say, “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 — private equity firms love to partner with founders.

They like to be in a position to say, “We’re a founder-led organization. We partner with founders.” And founders are often figureheads and mouthpieces. And so oftentimes 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?

Would it be supplier relationships? Marketing expertise? Financial expertise? What are the various different ingredients that a sophisticated financial sponsor could 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 are gonna model this out.”
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 — considering partnering with a private equity firm. And it’s a hundred-million-dollar transaction. What sort of capabilities and levers could be pulled over the course of the next five 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 levers 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 gonna be worth five 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 sky-high. And now we’re in a very good position. So I think if you’re a seller — and again, you’re getting these inbounds in your email — you really need to think about this. And you should ask yourself, how can 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 not like, “Sure, well, 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 gonna research products. I’m gonna review things.”

“I’m gonna talk to my neighbors. I’m gonna think about what it is that I want, and then I’m gonna 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 equity.

Now, in both of the sell-side masterclasses, I talked specifically about running a formal sell-side process, so I’m not gonna 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 five years if you apply all these different levers through 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 where you’re dealing with both private equity firms and strategic acquirers. The more you know what you want to do, the more you are going to be in control, and the better off you’re gonna 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 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 shit that you don’t care about. Now you’re gonna be able to say, “Okay, private equity firm, 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 gonna 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 gonna 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 fungible, 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 wanna 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 wanna sell my business, and I’m not quite sure. What can you do for me?” No. “This is what I wanna 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 sell-side masterclass, 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. And 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 gonna end up leaving a ton of money on the table. You don’t wanna do that either. Again, you wanna 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 gonna get indications of interest.
The private equity firms are gonna say, “Hey, Michael, love your business. Here’s what we would do with it. We will pay between X and Y. Here’s how we’d structure the deal. You’re gonna roll, you know, 15% of the purchase price. We’re gonna keep you on. We’re gonna keep your right-hand man on.”
“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 ’em, right?

So you’ve got a lot, and you can lay ’em all out on the table simultaneously. And you’re gonna say, “Oh, this one’s a piece of shit, 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 controlled process works quite well.

When you’re doing a minority interest in a business, when you’re gonna do a growth equity investment, a controlled 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 — shit, you’re not giving up a ton of equity.
So I mean, you don’t have to extract every nickel off the table here. 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 book, your business, is being transacted for, right?

So you want to make sure that you get every penny you can, squeeze it all out. You wanna 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 gonna belabor that, because I talked about it extensively in the sell-side masterclasses —now you find yourself with a whittled playing field of 1, 2, 3 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 gonna be our platform, and this is gonna be our brand name.”

“We’re gonna do all these acquisitions, and we’re gonna make you the CEO.” And you’re feeling great. “I’m getting all this money. I’m gonna be a CEO. This is fantastic.” That might be an interesting opportunity for you, but you might have a shit-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. One’s a little bit bigger, it’s got a better brand name, so we’re gonna combine those two. We’re kind of working on the other one now. We wanna do it simultaneously. So we will use your business, but you can kind of stick around.”

“We definitely need you to roll equity, but you’re not gonna be the CEO.” And you look at it, and 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 they used one of the brands. They combined three of ’em. One of ’em 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 gonna build a hundred-million-dollar business. Some are kind of middle-market, or upper-middle-market — they’re gonna 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 in assets under management, or 2 billion, right? And so there are those sorts of considerations. And I think it allows you to really understand what sort of runway you’re gonna 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 gonna be a platform, where you’re gonna be a tuck-in — doing those sorts of things gives you some optionality. But at the end of the day, you’re the one creating a vision.

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 gonna very quickly self-select.

Like, “Do I want to do business with Michael? 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 info. You just got valuable information. That’s not the right party. Don’t waste time on them, because I can promise you there are 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 cutting 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 gonna use ’em 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 gonna be the big daddy, the CEO. They’re using your brand. You’re the platform. And you’ve done a great job, because in your sell-side 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 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 gonna 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 gonna sign a letter of intent.

And the letter of intent, I think, is important with private equity firms — and sometimes more important. Because, you know, in any industry, when you’re dealing with a strategic acquirer — and what I mean by a strategic acquirer is an acquirer 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 their reputation. They don’t wanna be the company that goes out and buys a company and shits all over it, and then gets a bad reputation, and then no one else wants to do a deal with them.

So they tend to be pretty careful. They tend to be more — 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 wanna make sure that 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 suss 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 gonna bring in outside industry experts. They’re gonna 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 are 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 a hundred million dollars for your business. “Sign this letter of intent.” You say, “Fine, I’ll sign the letter of intent.” We 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.”
“I don’t know if we’re gonna be able to do exactly what we want, because…” And you’re like, “Well, that’s how widgets are made.” And I’m just like, “Oh, I didn’t know that. I got this expert guy over here telling me that widgets are made differently. And I’m not quite sure. So I think we’re gonna have to make a new widget conveyor belt, which is gonna cost us money.”

“And so I’m gonna ding you on the purchase price. Congratulations. It’s now a $90 million deal.” And so you’re violently upset, because you wanted 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 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 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 process.

So you’ve thought it through, you’re ready, you’re excited. You’re gonna be the private equity kingpin. You have your name on the building. You’re gonna be the king of the platform. You are gonna take 70 million in cash up front, roll 30 million. You say, “Paul, I wanna 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 gonna be fun. But we take out the LOI, and we’re gonna 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 Grits 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 three-x liquidating preference in here. If things go south, you’re gonna 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 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 with a strategic. You know, a strategic acquirer in your industry, again, will understand your business. They know the shorthand.

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 gonna end up hiring a lot of people who you think are buffoons — people who can’t keep jobs elsewhere.

A lot of, in my own personal experience, 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 ’em 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, and 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 do financial due diligence and accounting due diligence. So they’re gonna bring in a large accounting firm that’s gonna be a total pain in your ass, which is why we’re gonna spend a lot of time on the front end making sure your numbers are shipshape before you even get into exclusivity.

Because once you sign that letter of intent, we’ve gotta 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 due diligence.

Financial and accounting due diligence, again, is the outside accounting firm looking through general ledgers. They want downloads of your Peachtree, 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 doing 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. And then they’re sitting down talking to you about the acquisition opportunities that you have, like, “Okay, when can we buy these add-on acquisitions that you brought up?” And meeting at Rick’s Shrimp and Grits, right?

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 sell-side vendor DD data pack. You could hire an accounting firm yourself to get your financials in order. Typically for us over here at Potomac, we have our own transaction advisory team in-house, 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 sell-side data packs, because we’re actually advising on the transaction. We 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. And the purchase agreement — it might be an asset purchase, it might be a stock purchase. It depends on how the transaction’s structured. But you’ve got your legal counsel working along, in conjunction with us, on drafting the legal documentation.

You are drafting the equity participation agreement, because, again, now we’re gonna be a partner with this private equity firm. So there’s a shareholder agreement that you’re gonna sign, and that’s gonna 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-led 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 sell-side advisor, 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 transaction’s 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 oftentimes, private equity firms tend to have maybe a hundred-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 gonna look like, what sort of reporting you’re gonna have to do, who you’re ultimately gonna report to. And ideally, if you played your cards right, we figured out a lot of this early on, 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 gonna attempt to do is two-x or three-x your business in as short 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 mid-sized 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 gonna be doing everything from maybe bringing in a new CFO, bringing in a new CTO, a CMO.

You are 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 gonna 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. 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 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 wanna check on things, they wanna 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 varied, informal conversations to educate yourself. And in fact, I mandate it to my clients. You know, we whittle down the playing field, and we’re down to like two or three financial sponsors, and 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’ve got 10 portfolio companies, and you give us three names, I wanna talk to the other seven. The companies they’ve already exited — what sort of returns did these guys get? What sort of problems did 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 the various different private equity firms you’re dealing 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. 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. 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 in 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 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’re gonna 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 mid-sized 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.

It 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 gonna 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, welcomed, 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 well.

Now, to recap here. Private equity firms take capital, they pool it, they invest it in the private capital markets. 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 a 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 could be specialists. They can be opportunistic in the way they go out and will buy anything, as long as they can get it at the right price. Or they’ll be thematic — they’ll choose specific industries or sectors that they’re gonna focus on, and they’re gonna consolidate that particular industry.

Private equity can work for you as a potential business seller, even if you wanna sell a hundred percent of your business. They’re oftentimes some of the bigger payers out there. They’re ideally suited for individuals who actually want to bring on additional resources and capabilities, who wanna 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-equity-backed 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 mind-boggling 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 sell-side 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 advisor, who’s gonna 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 Potomac, 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 if 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 Giannamore. Thanks for joining me today. I’ll see you on the next one.