Dating before marriage in PE: choosing the right business partner

By Mark Woods and Andre Puong, Cathay Capital

Mid-market companies, with annual revenues between $10 million and $1 billion, are an often-overlooked segment of the US economy. They make up only about 3% of companies but generate $10 trillion in combined revenue and represent about a third of US GDP – not to mention a major portion of employment opportunities.

With only 5% of mid-market companies backed by private equity firms, it makes sense to consider partnering with a PE investor in these uncertain times to unlock potential. Benefits include – financing growth opportunities, bolstering the balance sheet, refining and implementing strategic goals, facilitating a generational ownership transfer, effectuating an acquisition, and building out sales channels in new markets.

However, PE partnerships are not one-size-fits-all. Choosing the right partner is critical as business owners, management teams, and PE investors work side-by-side through various business stages. When approaching a PE firm – be it through the sale of a minority or majority stake – it’s important to be prepared and aware of the many complex facets of the deal.

Here’s what to think about first:

Bring in the right advisers

A lawyer, banker and other advisers will be essential to the success of a transaction, and it’s imperative to choose well. The first step is to identify advisers that have a strong understanding of the business and its ownership and have the requisite experience to help navigate the complexities and nuances of the process.

Partnership discussions are often botched because of an ill-chosen adviser being over-protective and creating roadblocks. We’ve seen situations where an attorney impeded the due diligence process due to a lack of experience in M&A, ultimately creating too much friction between buyer and seller and ending discussions.

Hint: interview several firms, ask advice from other business owners and always check references.

Prepare for a thorough due diligence and transaction process

Don’t underestimate the intensity of the due diligence phase. As professional investors and fiduciaries for their own investors (pension funds, family offices, former entrepreneurs), PE firms have a duty to dig deep to understand the good, the bad and the ugly parts of a business before investing. PE firms will bring their own “buy-side” advisors, specific to the nature of the business and the areas to be examined. This is all before or concurrent with negotiating the definitive contracts of the transaction and partnership.

Be prepared for a rigorous process and intensive period of gathering financials, operational data, and legal documents. There will be a thorough amount of diligence questions, follow-up questions and follow-ups to follow-ups. Commitment and responsiveness are essential, as is a pinch (or more) of patience.

Hint: Ask for the detailed due diligence roadmap, organized by week, early in the process. Hold PE funds accountable to the timeline, also recognizing dependence on seller responsiveness. There is a symbiosis between buyer and seller in a transaction process, and success depends on both parties being constructive. Ultimately, the seller’s hard work helps the PE buyer view the business in the best light.

Determine transaction goals – both personal and professional

Think about medium and long-term business goals and the implications from an organizational and leadership standpoint. Apart from maximizing value, what are the main objectives for the transaction? What would most benefit the company and employees? Compare that to personal goals, especially if the business owner is actively involved in day-to-day operations. Is the goal to continue running the company backed by a PE partner?  If yes, for how long?  If not, what is the ideal involvement (for example, staying on as a consultant or Board member) and retention of economic interest?

Mutual candor is important on both sides, as great partnerships start with a keen understanding of what each party is seeking and figuring out the ‘art of the possible’ in a transaction. Business owners aren’t alone in contemplating complex decisions – every seller wonders, is now the right time? And every partnership is different in its collective goals and how the PE team works together with the company post-closing.

Hint: Gain an understanding of how the PE firm works with portfolio companies and evaluate the firm while they perform due diligence. Again, the right advisors will properly guide the thinking through goals, types of partnership to seek, and the right PE partner.

Parting thoughts

The PE toolkit can be surprisingly flexible to address the specific needs of mid-market business owners and companies in today’s business landscape. The key for sellers is to be well advised, know what to expect, pick the right PE partner and understand the nuances of a transaction process. Lastly, it’s okay to ‘date before you get married’ in a company sale context – an analogy we frequently use as we cultivate relationships with business owners that sometimes take years before a transaction is ultimately consummated.

Mark Woods is head of North American private equity, and Andre Puong is a partner in Cathay Capital’s New York office. Cathay Capital Private Equity invests in North American small and mid-size companies through its Growth Investment Strategy and Middle Market Strategy.