A private equity firm just made an offer. Now what?

For most business owners, like you, the call, or the email, seems to come out of the blue.

It’s from a private equity firm. And they’re interested in buying your business.

While the overture often comes as a surprise, preemptive offers—those made before you’ve started a sale process—are becoming more common. Private equity (PE) firms have raised plenty of cash—$1.9 trillion in the United States since 2019.¹ That money has to be put to use or returned to investors. PE firms also have a record number of existing portfolio companies that are aggressively looking at acquisitions as a growth strategy.

If you’re at all interested in an offer from a PE firm or portfolio company, it’s important to assemble your team—starting with a lawyer who specializes in transactions—before moving forward. PE firms have dedicated resources, established processes for executing transactions and a roster of sophisticated external advisors at the ready. Business owners typically are not prepared.

Three primary factors need careful consideration when evaluating a potential deal: a detailed letter of intent (LOI); your own financial, personal and business goals; and a comfort level with the buyer.

A blueprint for a deal

If you agree to explore a potential transaction, the PE firm will begin due diligence. It will ask for a raft of documents, including historical financials, projections, and customer, product and supplier data.

The goal of the PE firm is to get to a signed LOI, which provides a blueprint for the deal. While the LOI is non-binding, it contains binding provisions, making it important to get a transaction lawyer on board before you sign. The LOI generally precludes the business owner from talking to other potential buyers. It also typically fixes the price of your business, although the buyer has the right to change the price based on their due diligence.

Business owners have the most leverage before the LOI is signed, and in order to grant exclusivity, sellers should make sure the valuation is worthy of a pre-emptive offer. While the temptation may be to focus only on price, scrutinizing other aspects of the transaction is just as important.

• Form of consideration. In addition to determining a price for your business, the LOI outlines the structure of the deal. It determines how, when and under what conditions the business owner will be paid.
  
  There will likely be a portion of cash at closing, a rollover of your equity into the entity acquiring your company and an earn-out that provides for additional payments if the business reaches certain milestones post-sale.
  
  The earn-out could last from one to three years, although some are longer. The earn-out could be based on revenue or profit. It could be paid out on a sliding scale or all-or-nothing.

• Rollover equity. Most business owners will roll some of their equity into equity of the acquiring company. The rollover into the acquiring company may be a good investment for you, but you’ll need to do your homework. You’ll also want to understand how and when the rollover equity will be taxed.
  
  You’ll also want to consider the nature of the equity that you’re getting. If the buyer and seller don’t hold the same class of stock, it can create risk and misalign incentives. Some firms use preferred equity, which may carry a dividend and may allow the PE firm to get its money back on an acquisition before the seller is paid.
• Tax consequences. In general, the buyer will want to buy the business’s assets, and the seller will want to sell shares in the business. This has important tax implications: A stock sale is typically taxed as capital gains, while at least a portion of asset sales are typically taxed as ordinary income.

Meeting financial, personal and business goals

The price and structure of the deal are only important to the extent that they allow you to meet your financial, personal and business goals.

You might approach them this way:

• Financial goals: A financial advisor can help. After a deep dive into goals and finances, many business owners find they need less cash than they had expected to meet their goals.
  
  Because so much of their net worth has been tied up in their businesses, business owners often haven’t taken advantage of strategies designed for liquid assets. A more thorough understanding of money management and investment often results in a more realistic picture of cash needs.

• Personal and business goals: If you’re looking for a capital partner that can help you take some chips off the table and diversify your wealth, a PE firm could be a good choice. The firm’s operating experience may help you expand the business or run it more efficiently. Longer-term, you might look to exit the business or even start another one.
  
  If your goal is to sell all of your business and retire immediately after the transaction, a PE firm might not be the best fit. PE firms prefer at least a partial rollover of equity because they want the seller to be motivated and invested and to keep working. But business owners are often in business for themselves at least partly because they’d rather not have a boss.

Know your buyer

The last factor is the acquiring firm itself. PE firms come in various flavors, each with its own expectations for acquired companies. Some PE firms have raised dedicated funds to acquire companies. Others (frequently called independent sponsors) find promising companies, lock them up with an LOI and then set out to raise money to buy them. Even if independent sponsors are able to raise the funds, this can extend the deal timeline.

The two main buyout types used by PE firms are platform companies and add-on investments.

• A private equity platform company is a new investment by a private equity firm that backs a management team to execute a strategy.

• An add-on investment is an acquisition by a platform company that helps the platform gain additional capabilities. These may include products, services or geographic coverage.
  
  If you’re being added onto an existing platform, you’ll want to understand its structure, financial performance, leverage levels and the likely timing of the portfolio company’s exit. It’s imperative to go in with your eyes open.

Sizing up your partner

After the deal closes, you could be working with your acquirer for an extended period. You want to make sure this is a firm you can live with, and that it has the expertise you need. Some firms bring operational chops. Some have an HR function to help upgrade your management team and key employees. Some are aggressive and sharp-elbowed—but if you’re dead-set on maximizing financial value, maybe that’s what you want.

Track records are important: How has the PE firm and its funds performed? Who are the people leading your transaction at the PE firm and what is their track record? If your company will be growing through acquisitions, does the firm have the capital to support this strategy?

As always, references are important. Understandably, the PE firm will refer you to its successes. So start digging. Ask to talk to a business owner who had a hiccup during the investment and still had a good outcome. Make sure you talk to companies that worked with the lead partner at the PE firm in charge of your deal. Search the firm’s website, which generally has a list of exits, and choose from those. If the firm won’t connect you, that’s often a red flag.

Building a team

While an attorney will be your first call after you speak with a PE firm, you’ll need to have a team to get you through a deal.

An accounting and tax advisor is crucial. Deal structures differ in their after-tax consequences and a skilled advisor can help make the deal more tax-efficient. Before signing an LOI, you may also want an accounting firm to put together a “quality of earnings,” which isa financial analysis that adjusts historical financials by removing historical non-recurring and non-operational expenses. (A quality of earnings could also adjust the company's financials for other reasons: the closing of a location, for example. Or perhaps the business raised prices or its profitability took a recent hit due to inflation or a higher minimum wage. This can yield a better picture of what the company’s financials are likely to look like post-transaction.)

A wealth management team can work with you to ensure that the sale of your business helps you meet your financial and personal goals.

Some business owners choose to hire an investment bank. This is not always necessary, but it changes the nature of the conversations with acquirers by creating competitive tension and can help keep the acquisition on track. An investment bank can also help you explore alternatives should the current offer fall through.

We can help

If you’re considering selling, your team at J.P. Morgan Private Bank can help you understand the scope of your opportunities, provide strategic advice, find specialist assistance and engage in the necessary pre-transaction planning for your company.