How Not to Sell Your Business to Private Equity : Two Scenarios

The industry you’re in is the hottest girl at the dance when it comes to private equity acquisitions. If you’re a business owner in this space I’m sure you’ve seen it firsthand – either a competitor has sold or you yourself have received calls, emails, and texts from hungry private equity firms.

This marks a huge shift. Traditionally small to mid-sized firms like yours sold internally to family or key employees, usually at book value. Alternatively, when owners were ready to retire they often just closed up shop, sold off equipment, and walked away.

Now, plumbing and HVAC owners are cashing in on seven and eight figure buy-outs1.

Multiples of EBIDTA (earnings before interest, depreciation, taxes, and amortization) are averaging 8.2 times2. This means private equity (PE) firms are willing to front you the next 8 years of your profits to buy your business.

How can they do this and still make money? It’s called multiple arbitrage.

1.      They buy your business at 8 times profits.

2.      They acquire 6 more companies just like yours.

3.      They add technology, efficiency, leverage, and aggressive marketing.

4.      They grow the bottom line.

5.      Then, they package this all together and sell to Wall Street for 15-20 times profits.

You’re in a high demand market so if you’re considering a sale to private equity, it’s imperative you plan ahead and build the right advisory team. This puts you in the position to maximize your exit and limit frustrations during the exit process.

As a financial advisor specializing in business exits, I’ve seen some great exits and I’ve seen some bad ones. To illustrate the power of planning ahead, I’ll share two real world examples.

Scenario 1: The Frantic Sale

Let’s start with how not to sell your business to private equity – what I call The Frantic Sale.

Imagine this: You wake up to a chaotic day at the office —one of your key employees has unexpectedly left, your supplier’s late delivery and increased prices jeopardize your biggest job, and your spouse is upset because you missed another evening together. Amidst this turmoil, your phone rings with an unsolicited offer to buy your business. Exhausted and vulnerable, you agree to a meeting.

Over a nice steak dinner and an expensive bottle of wine, you settle on a $10 million sales price for your business, pending due diligence, of course. But as the process unfolds, the private equity (PE) firm starts to scrutinize every aspect of your business and financials. They adjust the price, and what began as a $10 million promise falls to $8 million.

The proposed deal structure forces you to leave $1 million of working capital inside the company, agree to a $1 million escrow holdback for the 18 months, and roll another $1 million of the sale price into their private equity fund as a “show of faith.”

When the deal is all said and done, you’ll receive $5 million in cash, before taxes. Far from the $10 million deal you initially envisioned.

Just as you begin to accept this bitter truth and look forward to a well-deserved break on the beach, the night before closing you receive one last bombshell: an urgent message from the PE firm, citing an overlooked accounting item that requires a further $500,000 deduction in the sales price. Frustration boils over. It’s at this point you realize, this is the first and only time you will sell a business to private equity, but they have done this hundreds of times.

You’re angry, disillusioned, and tempted to back out—but the fear of restarting this grueling due diligence process with a new buyer forces you to relent. In the end, you sign off on the deal, and two days later, $4.5 million is wired into your account, you bank $1.35 million for taxes, and you net a little over $3 million. The entire process leaves you wondering if the quick exit was truly worth it.

Scenario 2: The Well-Thought-Out Exit

Now, imagine a different path—one where you don’t just hope for a good exit, you engineer one.

Instead of waking up one day exhausted and accepting the first offer in your inbox, you start planning proactively three years in advance.

You assemble a trusted advisory team. (The Dream Team)

1.      Engage a CPA experienced in exits to clean up your books and provide a quality of earnings report. You commission a business valuation so you know exactly how much your business is worth and the levers you can pull over the next three years to maximize your sales price.

2.      Engage a mergers and acquisitions (M&A) attorney to help you prepare for the deal, and implement asset and estate protection strategies. You review entity structure and ways to legally minimize the taxation of your exit.

3.      Engage a Certified Financial Planner® (CFP) practitioner who can help you understand the true value of your exit. Is the after tax amount of your exit enough to accomplish your long-term financial goals? How much will you really be spending post-exit, especially once the business piggy bank is gone. Additionally, they will create a disciplined investment strategy designed to support a lifetime of financial security.

4.      Finally, when you’re ready to move forward on a sale, you engage a business broker or investment banker (depending on the size of the transaction) to actively market your business to multiple buyers and run a competitive bidding process – because one offer isn’t enough. You need leverage.

Now, you’re not pressured into accepting the first offer that comes your way. Instead, you’re evaluating buyers.

How have they treated other sellers and their employees post transaction? What is the culture and values fit with your team and customers? What’s their track record for making previous seller money on the “second bite of the apple?”

Because you started this process early, you have taken the last few years to optimize key value drivers in your business - you’ve diversified your customer base, increased profits, and built a solid management team.

After reviewing firms and offers, you’ve settled on a $17 million deal with a firm that’s a great fit. (It’s common that the best offer isn’t necessarily the highest one.)

After this PE firm conducts due diligence and proposes some adjustments, you’re prepared for normal negotiations and minor tweaks. For instance, after all the details are ironed out, you agree to an $15 million deal immediately with the opportunity to earn the other $2 million over the next two years as an earn out. You’ve negotiated $1 million to be left behind in working capital, and $1 million in an escrow holdback but just for 12 months. And you excitedly agree to invest $1 million of your proceeds back into the private equity fund because you’ve seen their impressive track record.

Now, PE firms will be PE firms so at the last minute they try to squeeze you for another adjustment. But because you’ve run a disciplined, competitive bidding process, you confidently stand your ground. They know you have other options. Ultimately, they stick with the deal.

When the dust settles, $12 million is wired into your account. You bank $4 million for taxes – probably less, thanks to smart planning. You walk away with $8 million in net proceeds, and a financial foundation that supports the lifestyle you actually want after exit.

Key Takeaways

1.      Begin Planning Early: Start your exit strategy years in advance. Knowing your business's worth and the key levers that increase its value will empower you to optimize its sale price.

2.      Maintain Impeccable Financials: Ensure your financial records are up-to-date and thorough. A professional quality of earnings report is essential to withstand due diligence scrutiny and justify your asking price.

3.      Assemble a Skilled Advisory Team: Don't navigate your exit alone. Collaborate with a seasoned team including an M&A attorney, CPA, CFP, and a business broker or investment banker to guide and protect your interests throughout the sale.

4.      Leverage Competitive Bidding: Engage multiple potential buyers to ensure you receive the best offer. A competitive process not only gives you options but also provides leverage in negotiations.

By comparing these two scenarios, it’s clear that a well-thought-out, proactive approach not only maximizes the value of your business but also ensures a smoother, less stressful exit. With proper planning and the right team in place, you can confidently step into the next chapter of your life—knowing that you received the full value of the business you’ve worked so hard to build.

My team and I have helped many business owners gain confidence and clarity in planning for their exit. If we can be of any help, contact me directly at brian@boyd-wealth or visit our website at boyd-wealth.com to learn more.

Happy planning,

Brian

Sources/Further Reading

1.      https://www.wsj.com/business/entrepreneurship/plumbers-hvac-skilled-trades-millionaires-2b62bf6c

2.      https://www.philipasaunders.com/the-rising-tide-of-private-equity-investment-in-the-home-services-sector/

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