Understanding the Diverse Worlds of Main Street Acquisitions and Private Equity
In the ever-evolving landscape of business acquisitions, a new trend is emerging. Private equity firms and private investors, traditionally focused on high-end, large-scale investments, are now venturing into Main Street acquisitions. This shift, while promising, brings with it a clash of cultures and expectations. As these two worlds collide, it’s crucial for both parties to understand their differences in order to facilitate successful transactions. This article aims to shed light on these differences, providing insight to help bridge the gap between Main Street business owners and private equity investors.
Different Financial Metrics and Language:
One of the most striking differences lies in the financial metrics and language used. In the realm of private equity, EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is the most commonly used metric. However, in Main Street acquisitions, Seller’s Discretionary Earnings (SDE) is more prevalent. SDE offers a clearer picture of a small business’s profitability by considering the owner’s benefits and perks. This shift in metrics can often lead to misunderstandings if not properly communicated.
Documentation and Sophistication:
Private equity investors are accustomed to a high level of documentation and corporate sophistication, which is often lacking in small Main Street businesses. These businesses may not have detailed financial reports, forecasts, or formal business plans. The owners of these businesses, while experts in their trade, might not possess the corporate acumen that private equity investors expect, leading to a disconnect in communication and expectations.
Transaction Structures:
In the private equity world, transactions often begin with a Letter of Intent (LOI), followed by detailed due diligence before reaching a final agreement. In contrast, Main Street acquisitions typically move directly to an Asset Purchase Agreement, streamlining the process. This difference in approach can create confusion and misaligned expectations about the transaction’s timeline and complexity.
Working Capital and Valuation Expectations:
Another significant difference lies in the treatment of working capital. In Main Street acquisitions, it’s common for the buyer to bring working capital, whereas private equity investors often expect it to be included in the sale. Additionally, small business owners view their accounts receivable and cash reserves as personal earnings and are reluctant to include them in the transaction. This leads to differences in valuation, where businesses are priced with the assumption that working capital is not part of the deal, a concept that might be unfamiliar to private equity buyers.
Personal Expenses and Business Valuation:
Many small business owners use their company as a “piggy bank” to fund personal expenses, a practice that can be alarming to private equity investors who are used to more formal accounting practices. Nonetheless these “perks” often represent a significant portion of the financial benefit owners derive from their business and should not be dismissed out of hand.
The Challenge for Business Brokers:
As business brokers our role is to navigate these differences and align the expectations of both parties. It is a delicate task that requires educating both sides about the other’s norms and practices while managing the intricacies of deal structuring in a way that satisfies both the buyer’s and seller’s needs.
Conclusion:
As the trend of private equity moving into Main Street acquisitions continues, understanding these differences becomes paramount. By recognizing and respecting the unique aspects of each world, private equity investors and Main Street business owners can collaborate more effectively, leading to successful and mutually beneficial transactions. This convergence, while challenging, offers a great opportunity for growth and learning on both sides, paving the way for a new era in business acquisitions.
The Author, Anthony John Rigney is the Broker and owner at Quorum Business Advisors. If you are a business owner considering selling you business in the next 2 -3 years, we would love to offer you a free and confidential consultation. You can contact us here for more information.