Understanding Private Equity Groups | O'Keeffe & O'Malley

Understanding Private Equity Groups

Apr 07, 2021

Private Equity Groups (PEGs) can be a great resource to acquire or invest in a company. Not all PEGs are alike, so it’s important to have a good understanding of the differences so sellers know what to expect.

In the U.S. alone, there are thousands of PEGs of different sizes and structures. Most PEGs are made up of a management group and investors who are wealthy individuals or institutions. Those investors contribute large amounts of money into a specific fund that remains open for investments for a period of time. PEGs will acquire companies that fit certain criteria while leveraging their acquisitions as much as possible. Some acquisitions are treated as platforms--a larger purchase with certain size requirements. Sometimes smaller companies are purchased as “add-ons” that are consolidated or merged into a specific industry platform, creating efficiencies by eliminating redundancy. The management group is highly incentivized to grow the earnings of the portfolio companies in each fund and increase the value of the investments. Usually, the fund remains in place for a five- to seven-year time frame, after which the investments are sold to other private equity groups, public companies or investors for a nice profit. In some cases, larger companies might be taken public.

Most PEGs are funded, meaning they have a specific amount of money committed or raised in a fund/entity to use for acquisitions. Unfunded PEGs don’t have committed capital and have a group of investors with whom they review acquisition prospects to get commitments. These less desired unfunded PEGs will go out and shop a transaction to many investors including other PEGs, hoping to get a piece of the transaction either in equity, or for a fee, or both. We advise caution when dealing with a group that shops a business to multiple parties, as it opens sellers up to significant risk of breached confidentiality.

The management of the PEG usually takes a fee totaling a percent of the transaction when it is consummated.  Additionally, they may receive a management fee to oversee each business investment.  And, as part-owner of the companies, they will participate in distributions of earnings and may receive a percent of the growth of the value of a company when the company is eventually sold. 

In today's environment, most PEGs prefer the seller to remain engaged in the business for several years because they don’t have the resources to run the business. If the seller has a strong management team, they may be able to negotiate an earlier exit. Many PEGs are making acquisitions in the form of a Recapitalization, Management Buy-out or Management Buy-in so they can keep key people in the organization involved. A Recapitalization allows an owner to sell a substantial stake in the company to diversify their net worth and eliminate bank guarantees. They retain an active role in the company and can look forward to a second payday down the road after the company has grown and the PEG is ready to exit. We have seen some second paydays that are larger than the first.

In a Management Buy-out, the PEG partners with existing management to buy out an owner. In a Management Buy-in, an industry experienced management person or team from the outside comes in and partners with the PEG to acquire a company.

As an M&A firm, O’Keeffe & O’Malley is contacted by about 25 PEGs a week looking for numerous types of companies. We have sold companies to PEGs and we have represented PEGs in acquisition searches. Our experience with PEGs has been positive, but we have also seen many unfunded PEGs that have been of concern.

If approached by a PEG, sellers should ask:

  • Do you have a specific committed fund or must you seek funding?
  • How large is your fund?
  • How long do you normally hold your investments?
  • Are you looking for control or a minority ownership position?
  • What is the minimum EBITDA threshold you are looking for?
  • What companies has your PEG acquired in the past?
  • How involved are you in the day-to-day activities of running the business?
  • How long do you expect the seller to remain with you?
  • Are you seeking a recap, management buyout or outright purchase?
  • Do you require the seller to finance part of the price?

Getting clear answers to these questions will allow you to evaluate whether this type of transaction meets your needs. For advice about working with private equity groups or any other aspect of mergers and acquisitions, contact us at 913.648.0185, visit our website or mike@ok-om.com.