Actively Managing the Pre-Acquisition Process in a Private Equity Transaction - Part I

In this article Larry is speaking directly to Private Equity General Partners from his perspective as the CEO of numerous PE backed companies. These concepts are important for incumbent CFOs to grasp; first, to learn how to survive in a PE backed company and, second, to learn how to help make a PE backed company thrive.

PRIVATE EQUITY INVESTMENT CONTINUES TO EXPAND, WITH INCREASING NUMBERS OF INVESTORS LOOKING TO REALIZE ABOVE-AVERAGE RETURNS.

But the pre-acquisition stage can be extremely challenging, especially for general partners who will be actively involved in growing the company to achieve the expected returns.

As a CEO who grows and oversees businesses for a PE firm, I’ve worked with a number of GPs and family offices during the pre-acquisition stage.

I’ve seen how challenging it is for owners and senior management to effectively communicate the realities, risks and opportunities of the business to GPs and other investors.

The good news is that GPs have an opportunity to actively manage the process. By combining strategic and financial analysis with a host of soft skills, you can build trust with owners through the due diligence period to get to closing.

From a CEO’s point of view, here are the top five areas GPs can take the lead on to create a successful acquisition:

1. Close due diligence gaps

GPs often have a superficial understanding of owner-client relationships, concentration risks, repeat clients, and competitive positioning. To remedy this:

• Go two layers deep in understanding the people in the business. Often GPs will interview and assess senior leadership but not the people who are more engaged in direct client relations, daily operations and execution logistics.
  
• Research the sales cycle of the prime competitors. Compare your understanding of the target company’s track record with that of the main competitor(s).
  
• Interview suppliers and partners. This gives you an opportunity to assess the culture, market position and execution capabilities of your target company through the eyes of a third party.
  

2. Understand business fundamentals and execution

Going beyond the strategy and numbers to really understand the company is critical in building trust with ownership. To gain in-depth understanding:

• Go on a sales presentation. Seeing the pitch, interaction with the prospect, and how leadership overcomes obstacles or gaps will significantly help you when assessing and evaluating sales data.
  
• Attend an operating meeting. Observe the process of delegation and interaction of the attendees. Are actions linked to key strategic goals? Is there clear delegation and accountability? Are problems discussed and corrective measures assigned?
  
• Review business plans from the past three years. Learn how the team has assessed their performance compared to the plan and made adjustments to drive better overall performance.
  

CFOs play a significant role in this area. They can create trust via excellent reporting and confidence through exceptional business planning methods.

3. Determine the strength of the management team

The existing owner will likely leave the business within months.

As a GP, your investment will rest on the next level of leadership. So it’s wise to get to know them well, dealing with people, competencies and productivity early in the process.

Questions to ask include:

• Who are the up-and-comers in the company?
• Are there any skill deficiencies and are there plans to address them?
• How are innovation and new ideas introduced into the company?
  
• How does the company deal with challenging employees?
  
• Is the business operating with proper employment standards?
  

4. Get clear on investment objectives, time frames, and payments

For both the transitioning owner and the GP, lack of clarity and transparency on objectives, involvement, timeframes, and payments to the investment party is a major challenge.

More often than not, misunderstandings in this area lead to failure. As the GP, you can manage this by doing the following:

• Clearly describe your objectives and what will occur after closing. There should be no surprizes.
  
• Provide the CEO and senior leadership with a possible timeline if things go to plan. This allows them to line up execution with expectations.
  
• Explain your expectations for information, reporting, and frequency of involvement. This allows senior leadership to determine if additional resources will be needed to meet reporting requirements and to anticipate additional costs.
  
• If taking a fee, be transparent about it. Outline the “why” and what value the PE owner gets in exchange for the fee.
  

5. Ensure a proper fit
Ensuring the investment style of the PE firm aligns with that of the transitioning owner-operator and the PE firm’s partners in management is key to a successful transaction.

Nothing erodes trust at this early stage more than having the investment approach change, so:

• Be clear about your intentions for the future of the business. Be upfront about whether you intend to run the company separately, combine it with another similar entity in your portfolio, or strip out pieces and sell unprofitable divisions.
  
• Get to know the transitioning ownership team well. You may need to get to know their families as well. (On one occasion, I went through a courting process with a GP who did not take the time to meet the owners’ significant others. Because the GP did not build trust with all family members, the owners’ partners ultimately did not agree to the GP’s involvement.)
• Assess the culture and investment style. Many owners have built their companies by being very frugal and highly strategic, spending money where and when they need to according to lessons learned. Carefully assess where you can truly add value and build trust based on your assessment of the owner’s competencies as well as those of the new partners in management.
  
• Be clear on the owner’s role going forward. Explain the duration, upside, and expectations for all members of ownership group. If roles will change after closing, clearly outline your expectations.
  

Actively managing these five key areas can significantly improve the pre-acquisition process for the GP and for those operating the target company.

From my perspective as a CEO, a GP who pays attention to the soft assessment and people-related aspects of the business helps everyone start off on the right foot and sets the stage for a successful investment.

Ready for Part II? Click here.

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