(Charlotte, NC – April 3, 2018)
In this six-part newsletter series, we highlight key practices that private equity investors put in place during the M&A process and address ways in which strategic buyers can borrow and/or adapt these practices to compete for and win quality targets. This week we will look at the second key practice: business exit strategy.
One of the main tenants of private equity is to hold investments for a shorter timeframe than is typical for a strategic buyer. Private equity firms are generally required by investors to exit their investments within three to five years, and rarely hold an investment for more than seven years. The short-term timeline forces disciplined business and capital investment decisions with a goal of positive returns upon exit. Keeping their timely exit in mind, private equity firms place more focus on buying companies that have potential for near-term improvements and growth, implementing value-add initiatives like cost cutting and putting into place management metrics that are easy to track and linked to value increases. (1)
Because of the shortened holding period and the increased buy/sell velocity, the private equity industry has developed an M&A process that is well-honed and repeatable. As discussed in the prior newsletter, private equity firms use a disciplined emphasis on research and due diligence to identify target companies with potential for improvements. Rather than focusing on potential synergies during diligence as strategic acquirers often do, private equity firms also focus on the pipeline for bolt-on acquisitions and begin to assess potential exit strategies.
The best way for strategic buyers to compete with private equity is to play by both sets of rules. Strategic buyers will always have an advantage in being able to extract value from long-term holds and the strategic synergies of putting two businesses together. But, they can also adopt some of private equity’s best practices – instilling an urgency for turnaround completion and synergy realization, and even contemplating a hypothetical business exit strategy before the deal closes.
A flexible ownership strategy allows a strategic company to hold on to acquired businesses for as long as the company can add significant value by improving performance and fueling growth. But, the company should be willing to dispose of those businesses once that is no longer the case. Since the company is free to hold on to an acquired business, it has a potential advantage over private equity firms, which sometimes must forgo rewards they might realize by hanging onto investments over a longer period. (1) Although many companies go through periods of selling businesses, the purpose is usually to make a diversified portfolio more focused and synergistic, not to realize value from completed acquisitions. Given the success of private equity’s model, strategic acquirers should rethink the traditional taboos about exiting prior investments. (1)
(1) The Strategic Secret of Private Equity (Harvard Business School Publishing Company)
“North Inlet Advisors, LLC” provides financial advice to companies on capital formation, mergers, acquisitions, divestitures, restructurings, and other complex corporate transactions. North Inlet Advisors is not a retail broker-dealer, does not conduct underwriting activities, provide research, analyst reports, or solicit or carry accounts, or offer or sell securities products to retail customers. North Inlet Advisors is registered as a broker-dealer with the U.S. Securities and Exchange Commission (“SEC”) and is a member of the Financial Industry Regulatory Authority (“FINRA”) and Securities Investor Protection Corporation (“SIPC”). Please visit www.finra.org and www.sipc.org, or North Inlet’s regulatory webpage for more information.