The deck is being reshuffled; how can a business owner stack the deck to their advantage?

by Graham Morrison, Managing Director, Chapman Associates

M&A offers a great opportunity for business owners to capitalize on disruption by partnering with a growth focused, partnership oriented Private Equity group

Coronavirus has changed the business environment dramatically. Companies are navigating challenges never seen before. The crisis has brought many companies to their knees. Their competition is struggling too. Widespread disruption has come across the board. There will be a shakeout in every industry, continuing even after the crisis passes. Disruption, however, also creates opportunity. The bigger the disruption, the bigger the opportunity. While there are no winners in the Covid-19 pandemic, some businesses will emerge to dominate their space, and some will be swept under. Which businesses will seize the disruptor role, upending the previous competitive landscape and creating the new paradigm?

Astute business owners are looking to capitalize on the disruption. They are seeking a proactive strategy to move beyond survival mode and into the disruptor role. For many companies, the right strategy is to strike a deal with a growth focused, partnership oriented Private Equity group (PEG).

How does this make any sense? It may seem counterintuitive to suggest selling a business in today’s environment. On examination, however, this strategy makes sense, and now is the right time to sell a company. This opportunity is there for the taking today. It makes sense to reduce risk by taking some money off the table. An owner can protect the company’s future by sailing into the safe harbor offered by a PE partner. A business can gain access to capital, resources, and guidance to thrive in these challenging times. Rolling over a portion of equity will allow an owner to continue to participate in the future growth of the company and recovery in the economy. From a business owner’s perspective, the key component of the strategy is to keep a piece of the equity in the business. Most PEGs prefer that an owner keep some skin in the game. By rolling over equity in a deal, a business owner can participate in the upside created by a stronger company dominating in a stronger economy. In many deals, owners have experienced phenomenal returns on the equity they retained after only a few years of partnership with a well-capitalized buyer. The second bite of the apple can often be larger than the first.

What about current valuations? Valuations reached an all-time peak in February 2019. Valuations may be off their peak but remain historically rich. It is uncertain if valuations will ever return to the levels seen at the end of 2019, or when that might happen. Now is the time to be bold, to take the initiative, to strategize for the coming recovery. The forward-looking opportunity is much greater than the decline in valuations.

Is now the right time? The environment today represents the greatest opportunity in recent memory to shape a business’s future. The deck is being reshuffled; the opportunity is there to stack the deck. Exploiting the existing opportunity requires resources most companies do not have today. A well-capitalized PEG can bring those resources, and more, to the table. A PE backer can provide the capital not just to keep a business afloat, but to aggressively expand, market, invest, innovate. Armed with the strategic guidance and industry experience a PEG can provide, a company can grow and dominate. The right growth focused PE partner will provide the capital needed for strategic acquisitions, accelerating the growth of a business while taking out weakened competitors. A PEG can provide external fuel for their portfolio firms to benefit from disruption. By retaining equity and management of their business, an owner can lead from a position of strength.

Are there buyers today? Nearly every PEG is actively pursuing acquisitions right now. Forbes magazine reports that PEGs were sitting on $1.5 Trillion in cash at the close of 2019. Those PEGs are looking for opportunities to deploy that cash quickly. They seek out companies and industries where their capital and resources can move the needle. The current economic environment and strategic opportunities are right up their alley. They are actively looking for strong businesses with excellent management, even if those businesses are deeply affected by the Covid-19 crisis.

Does this strategy work? PE investment significantly improves the performance and survivability of companies, in both expansions and recessions. A 2012 study by Boston Consulting Group that 66% of private equity deals boosted a portfolio company’s annual profits by at least 20 percent, and nearly half of those deals lead to a profit increase of 50% or more. The evidence is clear that PEGs make a significant contribution to the performance of their portfolio companies. PE backed companies do better in recessions too. An April 2020 report by Bain & Company showed that PE investments during the Financial Crisis of 2008-2012 had better returns than investments they made before or after that period. A 2011 study in the Journal of Corporate Finance showed that bankruptcy rates were lower among companies backed by an experienced PEG versus companies that were not. Clearly, PE backed firms are better equipped to handle economic dislocations and thrive when the economy is growing.

How does a business owner pursue this strategy? The strategy warrants a proactive approach, guided by an experienced advisor. The advisor will help an owner find the most suitable PEG partners. There are over 3,000 PEGs in the US and thousands more worldwide. They differentiate by industries served, financial resources, management involvement, capital structure, geographic focus, strategic goals, and other dimensions. Choosing the right one to partner with is a daunting task. One size does not fit all. An experienced advisor will help select the right fit. The advisor will evaluate a business’s value, find a suitable partner, and help navigate the process to achieve the owner’s objectives. Chapman Associates is the most experienced advisor in the middle market. Founded in 1954, Chapman Associates has closed over 2,300 transactions. Contact Chapman Associates today to see if this opportunity is right for your company.