Some individuals, property trusts, investment trusts and private pension or superannuation funds are interested in investing in a private business purely for an economic return and have no intention of actually running the business.
They look for well run companies with strong management teams and good sustainable profits. Their normal mode of operation is to renegotiate the senior management team employment agreements to ensure the senior executives are motivated to stay with the business and to build the business over time.
They would normally restructure the Board of Directors and implement a Board of Advisors if they deemed that useful.
This is normally not a quick path to retirement for the prior owner however. Unless the investor can be convinced that the chosen successor has the experience and ability to take over the business, this is something which might have to be planned over a longer period of time. For the entrepreneur who wants to phase out of a business, or simply wants to cash up to fund their retirement but doesn’t want to give up working in the business, this may be a very successful strategy.
Private equity (PE) firms usually manage investment funds on behalf of wealthy individuals, pension or superannuation funds or investment trusts. The money is pooled and then invested and managed on behalf of the private investors.
Most funds have a limited life of ten years by which time they need to have sold their investments and returned the funds, plus any capital gains, to the private investors. PE funds seek a return above the rate of return which could be achieved by investing in property or the public securities market. Thus returns in excess of 15% are expected from a PE fund. However, because some investments may fail to deliver the anticipated returns, the PE firm will look for opportunities where a 25%, or greater, return can be achieved.
In some cases, PE firms will seek out under-performing businesses to purchase. They anticipate they can redevelop these, put them on a higher profit run rate and generate growth through better management. Other businesses are purchased which can be put together with one or more acquisitions to create a business which can be sold to a large corporation as a strategic sale or listed on the stock exchange.
Thus a business which is well run, profitable and growing may not present the ideal vehicle for a PE firm to leverage its investment.
A well run business with good systems, a strong management team and good growth potential might, however, provide the keystone in a roll up strategy. In this strategy, the initial acquired business is used as a platform to undertake further acquisitions until a much larger entity which can benefit from economies of scale can be built. At this stage, the business might be floated on the stock exchange or sold to a large corporation.
Roll up strategies seem to work best in fragmented industries where there are numerous potential acquisitions which do similar work in different regions or where products or services complement each other when they are aggregated. Often the PE firm is prepared to take on the task of management of the business at a Board level, putting in place a new or restructured senior management team. The PE firm will often inject new funds into the business as well as take on further debt to finance business restructuring, acquire updated plant and equipment, introduce more formalised reporting systems and fund complementary acquisitions PE firms are also prepared to work with entrepreneurs on a phased acquisition or a longer term joint exit. In this scenario, the entrepreneur sells down part of their equity enabling them to liquidate part of the wealth locked up in their business. The PE firm then works with the entrepreneur to build the business for a trade sale or public listing.
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