Vera (not her real name) sent me an email recently; I could tell she was excited. It seems a private equity (PE) firm is interested in buying her business and ready for her to sign a non-disclosure agreement (NDA). It must be love.
A bit of backstory. I met with Vera and her sister two years ago to discuss their interest in selling the business they took over from their father in 2004. The business has provided the sisters a nice lifestyle, but they haven’t reached that elusive point where they could sell it and retire on the proceeds. After our meeting in 2020, they said, “we’ll be in touch,” but I never heard back from them. So imagine my surprise to get Vera’s email a couple of weeks ago. As it turns out, they had decided to not go to market in 2020, but instead focus on the advice I had given them that might increase their business’ valuation.
Vera tells me she recently received an email, then a call, from a PE group interested in her business. As it turns out, this PE group seems to be interested in establishing a presence in her industry and told her they are ready to “get serious fast.” Vera had the good sense to ask for an NDA before handing over her financial documents. Now that she’s signed the NDA, she’s realized it might also be a good idea to have an advisor by her side through the conversation.
OK, so far so good. But here’s the rub. Vera’s business is not ready for private equity, though she doesn’t know that yet. Once the PE guys see her financials and learn more about her business, they will tell her that her business is too small and doesn’t have the growth potential they need to justify an investment.
Lest I sound like Mr. Negative, let me explain why I am so sure about this. Private equity will decide they like a certain industry or “vertical” if you want to use their language. Then they look for an initial entry into that vertical. That initial investment must have certain characteristics, such as an annual EBITDA minimum of $3 million (or more in some cases), and a management team that can stay around after the sale to provide a foundation for future growth. Since Vera’s annual EBITDA is under $2 million, and she and her sister are ready to retire, her business doesn’t have the bones to be the PE group’s entry into her vertical.
The good news for Vera is this PE group might come back around to buy her company after they’ve made their flagship investment. This is what’s called an “add on” investment. In the coming days, I will be talking with Vera and her sister about their options. She will be disappointed that this expression of interest doesn’t manifest itself in a transaction. It’s not fun watching an owner get excited about a potential buyer, only to find out it’s a mirage.
Vera’s situation is not uncommon. There are literally thousands of PE groups out there now, there are a lot of “Veras” out there who are finding themselves being chased only to realize they’ll be left at the altar (sorry to be mixing metaphors, but you get the idea).
Tennessee Valley Group
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