Private Equity: 6 Practices Founders Should Be Aware Of

Private equity funds buy complete or partial ownership stakes in mature businesses where there is an opportunity to expand the business, unlock currently unrealized value, or make it more efficient. In doing so, they accept the risk of implementing a strategy the current owners do not want or cannot take. There are private equity firms for most industries and sizes of businesses, but Private Equity is famous for large-scale leveraged buyouts of undervalued firms (think Gorden Geko trying to buy the shipbuilder to unlock the value of the ship building docks in the film “Wall Street.”)

Private equity investors put their own management teams and boards in charge of the business and usually seek a different strategy than its current trajectory, which has typically lack management know-how, funding, or ability to scale.

Private Equity can be an excellent buyout option for founders who have brought their company as far as they believe they can. The exit will be clean and professional. If a partial sale, founders should make sure that the strategy in the future is fully aligned on both sides,  making this a formal part of the agreement structure.

6 Practices Every Founder Should Be Aware Of

1. The common practice of “chipping away” at the offer price. For example, offer a specific price, and then as diligence items come up, the price paid for the business gets hit.

2. Non-competes to tie up leadership and employees. For example, if you sell the company, are unable to operate in the sector, or hire employees for the following five years

3. If a partial buyout, beware of preferences where it is positioned that the equity investors will get back 2X their investment before founders get paid any deferred proceeds from selling shares.

4. Private Equity often charges management fees to companies they own for the board and strategic services; these get paid before any other shareholders.

5. Loss of control in every way. Private Equity only wants one driver of the business, them.

6. Stripping the business of costs, which makes it more efficient in the short run but can lead to a structurally weak company in the longer term.

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