Should you take private equity to grow your company?

I recently had the privilege to meet with a company that has been on the Inc. 5000 list four years in a row. The founder successfully grew the company without outside investor capital. Over a period of seven years, the company engaged in expansion efforts and was growing on the East Coast. It faced a large opportunity to expand in Florida.

Unfortunately, at the time the company was offered the acquisition in Florida, it lost two of its biggest customers (a supplier undercut them). The loss of revenue impacted the company’s covenants with its line of credit, which the bank then called in.

This constrained the company’s operations and expansion efforts. The founder and his senior management team put more personal capital in the company, but it was not enough to support an acquisition.

The founders were absolutely opposed to taking private equity because they didn’t want to give up ownership.

Even the company’s current operations were struggling from the revenue loss, and they were forced to delay some supplier payments. More of their payables were extending into the 60- and 90-day time frame. They were now risking their reputation in the marketplace, and the banks were not eager to offer a new line of credit to assist the cash crunch.

 

Facing tough questions

Let me be clear: This is a solid company with millions in revenue, a good operating management team and a good customer base.

The company has the opportunity to continue to expand because its business model could take advantage of a fragmented industry and easily capitalize on acquiring the smaller players in the market.

They are now faced with the question of either selling what they successfully built, or taking private equity to assist cash flow and expand. The issue that haunts them is “giving up sacred control” in exchange for capital.

On the other hand, they are fatigued and can’t get a line of credit. If they sell now, with weak EBITDA numbers for the past year, and the current year, they will not get a strong price for a company they worked so hard to build.

 

Looking at the numbers

Let’s do the hypothetical math. Suppose that companies in this industry are being acquired for five times EBITDA, and EBITDA for our struggling company is $300,000.
The company could sell now for $1.5 million and barely repay the capital it invested a year ago.

Or it could take $2 million in private equity and give up 30 percent of the company. The company grows, and in five years EBITDA returns to a robust $5 million. Even if the industry multiple is still only five times, the company could sell for $15 million.

The 70 percent the owners retain is $10.5 million, a $9 million return and the leverage benefit from private capital infusion.

The moral of the story: An emotional barrier to private equity and ownership can blind you to the opportunity of greater wealth for you, the owner and the ability to put your company on track.