How to read current private equity trends, as a business owner

Investment professionals say: Don’t try to time the market, because you’re reacting to what has already happened. The same holds true for a business owner.

“We often see business owners who aren’t truly prepared to take their business to market, but they want to get it out there quickly to try to capitalize on what they see as a good market trend,” says Scott McRill, a partner in Transaction Advisory Services at BDO USA, LLP.

Private equity is a great alternative for business owners who want to exit their company, so it is important to keep an eye on industry trends, he says, especially if you’ve paid attention and prepared your company for the process along the way.

“The trends are a great indication of what a business owner might expect, but you can have wildly different opinions and results among different private equity firms,” McRill says. “These are good barometers, but don’t assume everything is going to follow this path. The standard deviation among individual deals can be sizable.”

Smart Business spoke with McRill about what he’s seeing with private equity and his advice for business owners as a result of these trends.

Trend 1: Family offices are fueling investments, competition

Family office investing in private equity has been around for some time and is not going away. A recent BDO study found that of the fund managers surveyed, 64 percent were raising new funds and 42 percent of those receive the majority of their financial commitments from family offices. (See infographic below) This investment pace is driven by skittishness about the stock market’s performance and confidence in private equity.

At the same time, some family offices have grown frustrated by their returns as limited partner investors. These groups have started investing directly in companies, creating more competition in the sector.

The biggest advantage of family offices is they don’t need to follow the typical model of holding on investment for five to seven years. If a family office finds a great company that’s producing cash flow, it may hold on to it for decades. This is appealing to many business owners who don’t like the idea of selling their business to private equity, knowing it will likely be sold again in a relatively short period of time.

Trend 2: Valuations peaking

The deal market has generally been a seller’s market for several years. Valuations have been high for sellers with a quality business. Valuations seem to be softening a little, and the shift from a sellers’ market to a buyers’ market may be coming soon.

Trend 3: Increased sell-side due diligence

The trend over the past 18 to 24 months toward an increasing occurrence of seller-side diligence is expected to continue into the foreseeable future. This kind of diligence — sellers pay for advisory services to ensure their company is ready for sale and that the numbers will stand up to buyer diligence before they take it to market — has been common in Europe, but it now has caught on in the U.S.

A decade ago, advisory services on the sell-side were seldom performed, except for large corporations carving out a division. Today, sell-side work can be 65 to 70 percent of a transaction advisory firm’s practice.

Private equity firms and investment bankers have pushed for this shift. They don’t want to invest time trying to get a deal done to later find out the numbers aren’t what they thought. Sell-side due diligence tightens up the range of value, improves the success rate of completed transactions and increases the deal’s speed.

So, what’s your takeaway for business owners in this environment?

No matter what the economics and deal market is like, you want to plan early and spend time tightening up your policies and procedures to get the business ready for buyer scrutiny. Too many business owners scrape by for years, and then decide they want to sell when there’s infrastructure missing and the records aren’t clean. Value gets lost when that happens.

If you’re thinking about selling in the next couple of years, act now to line up good accountants, an M&A attorney, etc. Although valuations may be about to start coming down, trying to race to market before being prepared will likely result in erosion of value in the long run.

Insights Accounting & Consulting is brought to you by BDO USA, LLP