Small Business Private Equity: Is it Right for You?

What is Small Business Private Equity?

Small business private equity follows the typical private equity model: private equity firms, or investors, buy a company and then grow it to prepare it for a later sale. The difference is, small business private equity firms focus on acquiring smaller companies— businesses typically in the range of $1 million to $4 million EBITDA or $5 million to $20 million in annual revenue. While larger private equity firms would not consider a transaction this small, they might if they are using it to add on to a company they are already invested in.

Do Private Equity Firms Buy Small Businesses?

Yes, small business private equity firms focus on buying small businesses, or businesses in the range of $1 million to $4 million EBITDA and $5 million to $20 million in annual revenue. While small businesses may seem undesirable for investors, the right business has lots of opportunity to the right purchaser. Private equity for small business investors seek small companies with great growth potential, as they have a high chance of improving that company’s value and therefore selling it for a higher purchase price later. This is the common private equity strategy.

What Types of Small Businesses do Private Equity Firms Look for?

Small business private equity firms seek promising small companies with high growth potential: in other words, stable revenue, ability to scale, strong market presence, and clear areas to improve. Strong management teams are also a plus. While stable revenue and a dominant market presence demonstrate past success, the ability to scale makes future growth likely. This combination is exactly what small business private equity investors are looking for.

So, what does a company’s ability to scale look like? For example, new equipment to be purchased, software upgrades to be made, a new geographic location to expand into, and more. These opportunities are often obvious to a potential investor and make the deal desirable.

Factors Private Equity Firms Consider When Acquiring Small Businesses

In addition to a company’s growth potential and stable past revenue, a private equity firm buying a small business looks for a wide, loyal customer base, and the high likelihood of a clean exit strategy after ownership. Since most private equity firms—even small business private equity firms— are looking to grow a company and then later sell it to make a profit, investors are often assessing the profitability of a future sale.

However, not all small private equity firms are created equal, and some firms prioritize long-term company health over making a quick profit. 1719 Partners, for example, is a long-term investor that takes company ownership as seriously as many family-run business owners do.

What is the Small Business Private Equity Process Like?

When a private equity firm is interested in a company, they will first reach out to the prospective company. Sometimes this introduction is made via an intermediary whose goal is to connect a buyer and a seller. From there, the buyer will conduct a formal business valuation. If you are curious what the value of your business may be, you are welcome to use our easy and free business valuation calculator.

When the business sale process has seriously begun, both parties voluntarily execute a letter of intent. This agreement sits between more casual interest and a finalized purchase agreement. Post letter of intent, the due diligence process begins: the small business private equity firm investigates the company to make sure financial statements are accurate, the facility is clean, reliable employee policies are in place, and more. This due diligence process is time-consuming, but it is required and is also an opportunity for the seller to showcase how valuable the company is.

After the due diligence process has completed, both parties move toward the final close.

How Do Private Equity Firms Value Small Businesses?

A small business’s valuation depends on many aspects, such as the company’s competitive landscape, EBITDA multiple, revenue, and growth potential. The EBITDA multiple is a very commonly used valuation method for small private equity firms. Simply put, an EBITDA multiple is the factor multiplied by a company’s EBITDA that yields the company’s enterprise value (valuation). While many factors increase the EBITDA multiple, the largest ones are a company’s growth potential, competitive landscape, and financial performance.

As discussed earlier, increasing growth potential, financial performance, and market presence leads to a higher valuation. The EBITDA multiple just captures these themes in one convenient number: the higher the multiple, the higher the company’s valuation.

What Does a Private Equity Deal Look Like for a Small Business?

Small business private equity transactions are often owner-focused, ensuring the previous owner’s personal and financial goals are met. This can look like the previous business owner remaining more involved in the company than he or she would be in a transaction with a larger private equity firm. For example, small business private equity transactions offer recapitalization, where the owner sells part of the business, remains a partial owner, and then when the company is sold again later, they receive additional proceeds. The structure allows the owner to effectively “sell their business twice” while slowly phasing out of ownership.

Larger private equity firms are typically less focused on the previous owner’s goals and offer less options to share ownership going forward. At 1719 Partners, we offer flexible deal structures to meet the owner’s goals while preserving their mission for the company.

Is Selling to Private Equity a Good Idea?

Selling to private equity is a smart option when you want growth support, a solid business transition plan, or flexible ownership going forward. The right private equity partner might even prioritize your company mission after the sale while meeting your financial goals for the exit.

For example, if you run a family business but lack a successor for the next generation, a private equity firm can step in and help find a new management team to replace you. At the same time, if you have a successor picked out but he or she lacks the capital to fund your exit, a private equity partner can help make these financial and personal goals a reality – for both you and for the successor. In addition, sometimes businesses need additional capital or resources to grow. Private equity firms can offer this growth financing as well as a wealth of resources and connections to take your company to the next level.

Slowly phasing out of the business is a great way to help your business uphold your founding mission, even as new partners hit the stage. It is also a nice way to “say goodbye” slowly to your company. Partnering with private equity offers these options.

How to Choose the Right Firm

It is important to find a small business private equity firm that has the capital and expertise to make your goals a reality, as well as one that aligns with your business vision. Vetting the firm is important: have they completed many successful transactions in the past, have previous business owners been good references, and have their acquired companies performed well? Exploring the private equity firm’s website can give you a good idea of their expertise and accomplishments. Having initial, casual conversations with the firm is also a smart idea.

The intangible aspects of a good partner are perhaps even more important than having capital and expertise. Will the firm preserve your company mission? Do you feel like your vision aligns with your new partner’s vision for the company? For many owners, what happens next with his or her company is important: will key employees stay involved, will current customers be taken care of, will facilities be upheld and reinvested in? The right partner is interested in keeping this vision intact.

1719 Partners is proud to focus on company owners’ visions and carry on the torch. For us, investing in companies is about more than generating positive investment returns—it is about making a positive impact. We are always open to having conversations. If you are interested in working with us, feel free to send us a message here.