The Four Types of Business Buyers. Part 2: Financial Buyers

Financial buyers have been big news lately—one in particular—but not because of deals they are doing to buy moderate-sized, privately held companies (read: human owned). In fact, financial buyers have been relatively quiet in that respect. Politics, not business, has put the spotlight on them.

Private equity funds, such as those run by Republican presidential nominee Mitt Romney’s Bain Capital, are financial buyers. My focus is how they operate, not the taxes they pay, because barring some major legal changes, private equity buyers are here to stay and one could well be the buyer of your business. Upwards of one trillion dollars is purportedly sitting in private equity funds, awaiting deployment as investments in other companies.



A typical fund controls millions of dollars. Its managers are looking for industries with significant growth potential and companies that provide the opportunity to create value for the fund’s owners. The fund may invest as a minority owner in a business, but most often, and my subject today, the fund will buy a majority of a company typically using some of its own and a significant chunk of borrowed money secured by the assets of the company it just acquired.

The financial buyer’s objective is to improve the target company’s performance so that it can sell the business (to a strategic buyer or another financial buyer) or take it public, in either case at a significant profit in three to five years. This focus means that financial buyer must be able to see a clear path to that result, it will not be swayed by the long-term potential of your business, and it will be very careful not to overpay for your company. This usually means the financial buyers will drive a harder bargain than the strategic buyers discussed in my first post in the series. This does not, however, mean that a deal from a financial buyer will ultimately be less desirable than that from a strategic. It only means that you and your financial and legal team have to work that much harder to evaluate the different offers.

A financial buyer rarely buys 100% of a private company. In many cases, some or all of the original owners will stay on as minority owners and as part of their management team. So, as closely as a financial buyer is evaluating you, you need to evaluate them. The value of your retained interest and your sanity is at stake. I’ll illustrate my point with two stories of companies I helped sell to financial buyers.

In both cases, my client, the original owner retained about 30% of the company, in one case the retained interest was equity; in the other, the retained interest was a combination of equity and subordinated debt (meaning that my client was paid only after the commercial lenders to the buyer were paid). In both cases, my client stayed on as part of management, but in a role that answered to managers brought in by the private equity firm.

I hardly heard from the first client after the sale until a few years later when the private equity firm sold the business it had bought from him. He told me he was making more money selling the retained 30% than he had from the original 70%. That’s the kind of picture-perfect ending that the private equity guys pitch when they talk to sellers. My second client, however, wasn’t so lucky.

From almost immediately after closing, my second client struggled answering to a bunch of “wet behind the ears” MBAs whom he thought knew nothing about the relationships with customers and suppliers that made the business successful. He complained bitterly that his formerly debt-free company was struggling with the debt the buyer had loaded on it.

Some business owners don’t do well when they aren’t the boss, so they aren’t the best candidates for private equity deals, but maybe my client was also on to something, because the business performed poorly as part of this private equity portfolio. After a number of challenging years, which included disputes with his “partners” and a couple difficult refinancings of the commercial debt, my client parted ways with the company he founded, getting almost nothing for his retained interest.

The lesson I hope you learn here is two-fold. First, be sure your after-tax proceeds from the initial sale are sufficient to meet your minimum goals for a sale and don’t leave you overly reliant on the financial buyer’s management of your former company. Second, pick your financial buyer carefully. Follow the link to a good New York Times piece on the due diligence you need to do.

Labor Day, the Bittersweet, Confused Legal Holiday

Summer's over.  That's the bittersweet meaning most people put to this legal holiday.  The confused part comes from the word "Labor." Beyond the oxymoron of a day off to celebrate work, many still associate the day with unions, when the focus is much broader: the work and workers that are the engine that powers our economy.

The U.S. Department of Labor tells us that Labor Day “is dedicated to the social and economic achievements of American workers. It constitutes a yearly national tribute to the contributions workers have made to the strength, prosperity, and well-being of our country.” The DOL doesn’t tell us that Labor Day was rushed through Congress by President Grover Cleveland to appease America’s labor movement a mere six days after his controversial use of federal troops forcibly ended the bloody Pullman strike that paralyzed rail traffic, and thus the country, during the summer of 1894.

Cleveland’s gesture didn’t work for him—his Democratic party was slaughtered in the 1894 midterm election—or help the labor movement that much either. Many needed reforms, such as reasonable working hours and safe working conditions, now taken for granted, would not be enacted for decades--decades that would include the infamous Triangle Factory fire and Colorado’s own Ludlow Massacre.

The Labor Day holiday illustrates that while the pace can be slow our country does eventually do what needs to be done.  Election-year finger pointing aside, what if, instead, we focused on the changes We the People can create without the politicians?

There are over 30 million human-owned businesses in our America. If only five percent of us (that 5% includes you and me, right?) committed to hiring at least one new employee before New Year’s Eve, together we’ve created at least 1,500,000 new jobs. All those new jobs means more business for all of us. Then maybe the politicos and the rest of the country will get the message and follow along.

So enjoy a day off, and then get back to the labors that made America great. 

I close with my traditional photographic farewell to summer.

a blogger and his mom