26 July 2023

The pros and cons of selling your SME to private equity

At a glance

  • Business owners considering selling part or all of their business to private equity firms should bear in mind that there are advantages and pitfalls of selling to private equity.
  • Advantages of selling to PE include access to the firm’s skills and knowledge and its wider network, as well as releasing capital from your business to fund your personal goals.
  • PE firms typically conduct rigorous due diligence and can be tough negotiators, so it’s a good idea to plan carefully before you start working out a deal. Watch out for long tie-in periods that require you to stay on for several years.

Whether you’re looking to exit your business altogether or just release some value, private equity (PE) firms might be an interesting potential buyer. There are advantages and disadvantages to selling to PE investors, so it’s important to take all considerations into account. 

Advantages of selling to private equity

Release capital and reduce your risk

As an SME owner, you’ll have built up value in your business throughout its life. That value may even represent a large part of your wealth. Selling part of your stake in the business to a PE investor can allow you to realise that value and free up capital to fulfil financial goals in your personal life while retaining a stake and role in the company.

Reducing the size of your share – or selling it altogether – also means you are less exposed if the business experiences financial difficulties. Andrew Shepperd, co-founder at Entrepreneurs Hub, says: “Talking to your financial planner should help you identify whether you have too much risk tied up in the firm. A private equity sale can help you de-risk, protecting you, your family and even employees, and allow the business to move to the next phase.”

Financial support

In addition to facilitating your exit, a private equity investment can provide a capital injection for the business. That means you could finance growth projects such as expanding operations or investing in new technologies.

The PE firm could also help you restructure your finances, for example by paying off debts or finding better loan rates. “A PE house could bring significantly larger resources to help you grow, which could be fantastic and transformational,” says Andrew.

Skills and knowledge

PE providers usually have industry-specific knowledge and experience and could advise you on anything from strategic planning to operational efficiency and market expansion. This can be particularly beneficial for SME owners who lack specific resources or expertise.

They also are likely to know how to help you improve your corporate reporting or governance structures as you grow.

“Even if you don’t go through with the sale, it’s worth meeting them to get a feel for where you are and ideas for moving to the next level,” says Andrew.

Networks and resources

PE houses typically have extensive networks and resources, so they may be able to connect you with potential customers, suppliers or advisers to support your growth. If you want to expand into a certain sector or region, seek a PE partner specialising in that area.

Disadvantages of selling to PE

Intense due diligence

Any buyer will scrutinise your company in detail, but PE firms can be particularly intense. A spokesperson for the British Private Equity and Venture Capital Association (BVCA) says PE firms will expect detailed documentation, such as financial statements, projections, cash flow analysis and valuation reports. That’s in addition to company records, contracts and other legal documents.

Andrew says this data must be in good shape and able to withstand scrutiny. “Your management accounts need to tie into your statutory accounts, or you must be able to explain why not,” he says. “We often find they don’t. Some small businesses don’t even run monthly management accounts, but they should.”

You’ll need strong metrics and business intelligence, plus a clear strategic vision. The BVCA spokesperson says: “To secure a sale to private equity, SME owners should articulate a clear vision for the future of the business, including growth prospects, such as untapped markets, new product or service development, or scalability, and highlight potential risks too.”

The PE firm will also want to know who will run the business in future, so you will need a clear succession plan.

Earn-outs or burn-outs?

Whereas you used to decide what happens to your firm, you’ll be in the hands of new owners post-sale, and they may have different ideas or processes. “Your new boss will also likely work you hard. Some are hands-on and controlling, others are more benign. But if the business is regressing, you’re likely to see them a lot more,” says Andrew.

Bear this in mind when negotiating the deal, especially if your buyers are pushing for a long tie-in period that requires you to work for the company for several years after selling. “Is it five years or seven years?” says Andrew. “That’s a long time if you no longer enjoy it. Go for certainty and try to get as much as you can upfront. Deferred sums are less risky, being time-bound only. Earn-outs are less certain and linked to conditions and performance that may or may not happen. If there are earn-out type delayed payments, negotiate realistic targets and payout levels. You will have to deliver these, not the investor.”

Tough conditions

PE firms are often hard-nosed negotiators. Good advisers are essential to help you understand and consider the conditions carefully. Be ready to stand your ground.
Andrew says: “It’s also crucial to understand what the buyers want you to do with the investment. You may be thinking about it going towards your retirement income, but they may expect a chunk of it to be immediately reinvested in the business.”

Unforeseen changes to the company

Because PE firms typically acquire a significant stake in the business, they will have significant influence. The new ownership may bring changes in the company’s culture, management and operational practices – which could impact employees and stakeholders. The BVCA recommends choosing an investor whose values and management style aligns with yours, and communicating your long-term vision transparently.

Andrew also recommends getting references from other owners. “Speak to three or four firms that have done that journey,” he says. “Ask about their experiences and whether they think it’s a good idea for your company. The buyer should make these contacts available for you.” Find out how other non-referred transactions worked out too.

How we can help

When selling to a private equity firm, planning your finances carefully is essential. For example, you may have been planning to pay a large dividend or pension contribution out of your firm’s income, but that could be made impossible by the structure of the upcoming deal.

“Sit down with an adviser, work out your finances,” says Andrew. “Before negotiations start, it’s critical to understand what number you need to meet your personal financial goals, and to ensure this transaction will support your timing and wealth goals.”

Where the opinions of third parties are offered, these may not necessarily reflect those of St. James’s Place.

Exit strategies may involve the referral to a service that is separate and distinct to those offered by St. James’s Place.

SJP Approved 20/07/2023

By Matthew Forbes