Acclaro Growth Partners' M&A and Strategy Weblog

Private Equity is Destined to Remain a Viable Option for Middle Market Sellers

Doom and gloom.  It is everywhere.  Articles are cropping up questioning the viability of private equity.  There are at least seven simple reasons that private equity will blossom over the next several years, or at least segments of it.

1.  Influx of Capital -- With the stock market unlikely to serve as a promising source of returns over the next year or two, private equity will continue to serve a strong role as an alternative investment.

2.  Restructuring of Private Equity firms -- PE firms are becoming more specialized to serve the unique needs of "special situations," industry segments, geographic regions, and they are bringing on more experienced operating partners to ensure they can add value post transaction.

3.  Transfer of ownership of middle market companies -- As aging baby boomers continue to reach retirement age, they will seek options for the sale of their business.

4.  The IPO route is less attractive -- Sellers generally have three options.  Sell to strategics, private equity groups, or go public.  With public company valuations down, the IPO route looks less attractive today than in the recent past.

5. Strategic acquirers may be gun shy -- Competition for acquisitions may be less intense than has been expected with strategic acquirers, who are concerned with the internal efficiencies of their own operations.

6.  Some private equity groups have unique access to debt  -- They use different names to describe themselves, but there are a number of funds that have internal access to debt and equity.  They see the lack of access to credit as an opportunity to get deals done quickly, with limited competition, and at great bargains.

7.  Private equity continues to add value to companies struggling to grow or become more profitable -- The rise of operating partners in funds, internal operational improvement consultants, the enhanced role of due diligence leading to 100 day plans, and the increasing role of consultants in private equity -- These are all signs that the industry is placing more value on actively improving the health of the businesses it invests in.

Private equity, at least some segments of it, will actually do quite well over the next couple of years.

Strategic Options for Private Equity During this Period of Uncertainty

In this period of economic, credit, and stock market uncertainty, private equity groups seem to be segmenting themselves into six groups relating to their attitudes toward new investments.

1.  Focus on the portfolio.  The folks in this group have consciously decided not to do any new platform investments for the time being, and instead, to focus on improving the profit-potential of the portfolio.

2.  Fight it out for credit.  Those in this group are trying to continue to do deals, business-as-usual, but have found the process of securing loans to be much more challenging than they expected.

3.  Over-equitize.  These investors are adjusting their expectations regarding the amount of equity they are willing to put into new investments.  As a result, they are looking at smaller and smaller deals (and are finding themselves competing with traditionally upper-mid-market-focused funds that are looking down-market for opportunities).

4.  Ask sellers to contribute.  The strategy of some buyers is to try, as early as possible, to convince sellers to take on more of the obligations to close -- by taking on some form of debt financing.

5.  Carve-out a unit or division.  Some buyers are trying to acquire only the segment of a business that they feel most comfortable with, or that they think stands the greatest chances of success.

6.  Focus on deals in a specific industry sector.  In order to reduce risk, some buyers are limiting their deal origination activities to industries sectors where they already have a lot of experience.  The intended result is limiting exposure during diligence and improving the chances of success of the deal.

Of course, these groups are not all mutually exclusive.  Private equity investors would be wise to contemplate pursuing each of the above strategies.