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Selling to Private Equity … Losing Control

Please, Jim, you have to help me unwind this disaster. The private equity firm’s pitch was so convincing, but those guys don’t know what they’re doing.”

I had never met Geoff (not his real name), but he was referred to me by his cousin who is a family friend. Geoff described his dilemma during our first call. “I sold my company four years ago. This PE group from Chicago made me an offer that was too good to be true, except it turned out to not be true.” Geoff went on to ask if I could help him regain control of the company. He told me he was ready to reinvest everything he made when he sold his company into buying it back.

Geoff was talking fast as he told me more. “They don’t know what they are doing. They’ve over-leveraged the company and now they’re laying off employees. I’ve known some of these people my whole life, I can’t just sit here and watch this happen. They’re telling the employees this is the only way they can fund the debt, but they are losing customers because nobody is there to take care of them.

I told Geoff I’d do some research on the situation and get back with him. I then called the managing partner of the PE firm that bought Geoff’s company. Knowing that most PE firms like to turn their investments every five to seven years, I assumed they might be open to the idea of selling, having already owned the company for four years.

Little did I know when I called the head of that PE firm that I’d be getting an interesting and valuable lesson about how private equity actually works. As a starting point, you have to realize when it’s all said and done, a PE investor is driven by one objective: get its investment back with an above-market return, ideally in the range of 30% year over year. However they get that financial return is fine, even if it calls for eventually weakening the company. As a general rule, PE investors are not long-haul investors.

The head of this PE firm told me they had grown Geoff’s company quite nicely after buying it. Revenue almost doubled in the first two years they owned it. So the PE firm did what they had a right to do, they leveraged the company to pay themselves a handsome dividend. You might hear this referred to as “taking some chips off the table.” By the end of the fourth year, the PE firm was on track to get their 30% year over year return on the investment.

The problem was, the PE group over-leveraged the business. To not violate the bank loan covenants, they needed to reduce expenses, i.e., lay off employees. Now the head of that PE firm did not strike me as evil or mean spirited, he made it clear he didn’t like having to lay off employees. But remember, his first priority is to get a financial return for his investors, and that starts with not violating the bank loan covenants. He calmly explained that he was OK with the decision to dramatically scale back because they were on track to get the return they expected from the business.

The power of leverage will be the subject of another blog, maybe it will be a series of blogs. Suffice it to say, through the power of leverage, the PE firm reached their financial objectives at the expense of the future long-term health of Geoff’s former business and its employees. There probably isn’t much Geoff can do. When selling your company to a private equity investor, the business owner is exchanging cash today for control of the company’s future. What happens after the sale is something the former owner cannot control. If the business owner is not truly comfortable with that loss of control, he should not sell to private equity.


JIM CUMBEE is President of Tennessee Valley Group, Inc. a retainer-based business brokerage and transition mediation firm in Franklin, TN. Cumbee is an attorney and has an MBA from Harvard Business School. He has a wide range of corporate and entrepreneurial experiences that make him one of the most sought-after business transition advisors in the state of Tennessee.

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Tennessee Valley Group

Jim Cumbee established Tennessee Valley Group to help business owners fulfill their dreams for life after business ownership. It’s a mission that his 30+ year career history had prepared him well for—in addition to being an attorney, transition mediator and business broker, Jim has been a buyer, seller, and entrepreneur. His broad range of experience gives him unique insight into how business buyers and sellers can achieve their goals.

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