Private equity firms may show a lot of interest in your business; be ready to ask a lot of questions about theirs.

October 05, 2017

The phone rings. Without thinking, you pick it up.  

"Hi, this is John Smith, and I'm with Middle Market Capital Partners."

Before you can say hello back, he launches into a spiel about who he is and why his private equity (PE) firm is so different from all the others. Maybe it is, but the words all sound the same. You briefly consider hanging up.

After all, you get these calls all the time. You have built a nice little company, and you suppose it is only natural that it would attract some attention. But you cannot help feeling that these guys just want to steal it from you. Still, despite how much you love your company, you do not want to work forever.

So you listen to his pitch about "MMCP's successful track record."

You thank him for calling and politely, but firmly, explain that you are not looking to sell right now and that it is not a good time for him to visit. He sounds disappointed but promises to call again in a couple of months.

You cannot help but shake your head because you know another John will be calling soon.

Sound Familiar?

We hear stories like this from clients all the time. We can hear the frustration in their voices when they tell us about them. Still, we encourage clients to take these calls, at least from time to time, because calls like these can be valuable sources of information – if you know what questions to ask.

Why Are They Calling?

Most companies are sold in an auction process. Stout's Investment Banking group specializes in processes just like these, and we firmly believe that a carefully run auction process will maximize value. The PE firms know this, too. They desperately want to avoid auction processes in order to avoid paying a market clearing price. Make no mistake about it, they are calling because they have a strong motivation to pay less for your company, which means they will generally stay on the phone with you, even after you start asking them questions.

And that is what we recommend you do. Ask them questions. Gather information. Make the call productive for you.

What Should You Ask?

Start by asking them why they are calling. Push them a little bit. Ask how they came to know your company. Why do they like companies like yours? What do they know about your industry? Have they ever invested in a company like yours or one in your industry? The PE community tends to be well-connected. They can be valuable sources of information. That is especially true if they have experience in your industry. Pick their brain; you might be surprised at the information you uncover.

It is worth asking a little about their firm. Do they have committed capital? This is important because some sponsors are fundless and do not have committed capital at their disposal. (For each deal they do, they have to raise the financing. That takes time, and there is no guarantee they will be successful at raising the capital.) If they have a fund, how much dry powder (capital that is committed but has not yet been invested) is left?

Then push to the interesting stuff. How do they think about valuing companies like yours? They will almost certainly dodge the question the first time you ask it. They will fish for more information about your company. It is OK to be vague. Tell them how big your company is. If you feel comfortable, discuss cash flow generation (again, it is OK to be vague). Once you have provided some basic facts, make them answer the question: How do they value companies like yours?

If you feel like spending a little more time on the phone, it is probably worthwhile to ask about how they work with companies they buy. Are they actively involved in operations, or do they stick to financial engineering? Do they have any relationships – in the industry, with customers, with potential recruits – that could be useful to your firm?

Do you like what you hear? If so, great! You identified a good potential buyer for your company – whenever you are ready to sell. If not, you still gathered some data about what your firm might be worth to a PE investor. If they like what they hear, they will likely want to follow up. Often they want to visit. Even if you like them, we recommend you do not agree to this. There is no reason to; it is another way they try to avoid an auction. If they like your company, they will let you know by bidding aggressively at auction, and they will have a chance to visit as part of that process.

They might be the best buyer. They might be completely standup guys (as much as we like to give them a hard time, many PE investors are good people – many we call friends). But even the best, most trustworthy buyers are rational actors. That means they will not pay more than they have to. They should have to pay a fair market price, determined by supply and demand. Keep them honest. Create a market. Run an auction. They all buy companies in auctions.

How We Can Help

We run auctions for companies every day. We deal with literally hundreds of sponsors (PE funds, family offices, and others – the guys that call you) constantly. We speak their language and know how to corral them into an auction. We keep track of how they behave in auctions and can help you avoid bad apples. It is all about creating the best outcome for you and your business. Let the market tell you what it is worth.