Dispelling Myths about Private Equity Buyers
We have all heard the horror stories from lower middle market business owners. Private Equity buyers will come in and get rid of all of my employees, borrow an absurd amount of money to finance the acquisition, thereby straining my company’s balance sheet and income statement, and then, light a match Goodfellas-style when they are done extracting value from it. But, I’ll let you in on a little secret? The days of financially engineering a path to outsized profits are long gone. While there certainly was an era where Private Equity funds looked to lock in a guaranteed “win” by over-levering the balance sheet, stripping the Income Statement of “fat”- read, people- and quickly flipping to monetize the win, those days are largely behind us. Today, most professional buyers value the team in place more so than any perceived competitive advantage with the product or service offering. I’ll say that again, buyers often view the team as the most important determinant of success- more so even than the core product or service offered by the business. Let’s rewind a bit. The perception of private equity by most of society is pretty negative. And to be frank, that reputation, although dated, is well-earned. Many have read or seen (it was first a book and later adapted for film) Barbarians at the Gate. The book details the leveraged buyout of RJR Nabisco by Kohlberg Kravis Roberts (KKR) in the late 1980s. While there are many takeaways from the book, the one most recalled is the impact that the use of junk bonds to finance the transaction and degree of leverage overall had on the business. Several thousand jobs were eliminated as a result. This deal wasn’t a standalone incident but rather emblematic of a strategy of the times; Finance the transaction largely through debt, thereby requiring only a relatively small equity investment by the buyer and reducing headcount to service the debt and prop up profitability. This is one example of how one might financially engineer their way to a profit. The cost to the business is often catastrophic; still, by the time the downstream issues present themselves, the fund has either sold or doesn’t care as they’ve extracted enough out of the company to more than satisfy their investors (LPs of Limited Partners). So, this negative perception is certainly well-earned. But why is it dated?
