Deal Killers and Deal Makers: A Private Equity Perspective
Jul 1, 2024
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Explore deal killers and makers in private equity, including customer concentration, off-balance sheet liabilities, and cyclicality. Learn how to address risks through sales strategies and why exit planning is crucial. Gain insights into private equity fund sizes and deal requirements. Discover tips on making your company attractive to private equity and navigating creative accounting in deals.
Customer concentration is a major deal killer for private equity firms, requiring proactive solutions for risk mitigation.
Off-balance sheet liabilities like unreported tax obligations can jeopardize deals, necessitating safeguards like reps and warranties insurance.
Businesses impacted by economic cycles can enhance attractiveness by shifting towards recurring revenue and diversifying customer bases.
Deep dives
Customer Concentration - A Deal Killer
Customer concentration, where one customer contributes a significant percentage of a company's revenue, is a major deal killer for private equity firms. High customer concentration poses risks such as sudden changes in demand and payment terms impacting working capital. Generally, scrutiny increases when customer concentration exceeds 25%, with a market threshold often set at 30%. To address this risk, creative solutions like adjusting revenues distribution or implementing contingent payments can be considered to mitigate concerns and facilitate a deal.
Off-balance sheet liabilities, such as unreported tax obligations or other hidden financial commitments, can undermine a deal. An example highlighted a discrepancy between reported and actual earnings due to potentially illegal income tax shield practices, significantly reducing EBITDA upon investigation. Strategies like escrowing proceeds or securing reps and warranties insurance may help mitigate such liabilities to ensure a smoother transaction.
Deal Cyclicality - Economic Dependency
Financial attractiveness to private equity is hindered when a business is heavily impacted by economic cycles or industry trends. Industries like construction, known for volatility, raise concerns among investors due to unpredictable revenue fluctuations. Transforming business models towards recurring revenue streams and diversifying customer bases can counteract cyclicality, rendering the company more resilient and appealing to potential buyers.
Size Requirement - A Factor in Investment Suitability
The size of a business plays a crucial role in attracting private equity interest, with larger companies generally garnering more attention. While minimum thresholds vary, businesses with EBITDA around 3 million or higher are typically more attractive. Smaller companies can still find buyers, particularly as add-ons, but scaling up can enhance appeal to a broader spectrum of investors.
Creative Accounting - An Alarming Truth
Engaging in creative accounting practices, like misrepresenting customer renewals or inflating EBITDA through unrealistic assumptions, can be detrimental to deals. Misleading financial reporting can drastically impact company valuations and buyer perceptions, potentially leading to failed negotiations. Proper financial due diligence and transparency are essential to avoid deal breakers stemming from questionable accounting practices.
Major Deal Killers: A look at the risks private equity firms consider, such as customer concentration, off-balance sheet liabilities, cyclicality, business size, and creative accounting.
Address Risks: Tips on how to proactively address risks and liabilities like customer concentration through sales and marketing strategies to diversify and grow the business.
Exit Planning: Hear why it’s important to begin preparing for your exit almost as soon as you start your company.
Private Equity Firms: Gain insight into private equity fund sizes, typical deal sizes, and requirements for platform vs. bolt-on acquisitions.