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Make Your Company One that a PE Firm Wants to Invest In

09.09.14

What kind of company does a PE firm look to invest in? A company with CLAMBUS! CLAMBUS means a company with the following qualities:

Cash machine

Litigation free

Audited financials

Management team

Barriers to entry

Unregulated

Scalable

Rank your company on a 1-10 scale in each category. This is like golf-lowest score wins – so a one is the best score. You only have to play seven holes in this game so a perfect score is seven and the worst score is a 70. My own view is that you need to be at least a 20 to interest a PE firm. You need to ace at least three or four of the CLAMBUS categories and the Cash machine and Scalable categories almost certainly need to be aced.

All seven of the above factors are important, but (as just noted) the first and last are likely the most important. If your company generates lots of cash and is scalable, then a PE firm will likely be very, very happy to become your business partner. Remember, a PE firm initially finds a platform company in a certain space to invest in. The PE firm “partners” with the platform company (actually, the platform company’s management team) and then does “add-on” acquisitions of other companies under the platform company (so that the sellers in each of the “add-on” deals is selling to the platform company that is now backed by the PE firm). The owner(s) of the platform company will, thanks to the PE firm, go from playing on the school playground to playing at Disneyland. The management team at the platform company can go from running their original company to running a company many, many times the size (as to revenues, people, and territory) of their original company. Some people thrive as a result of this change and others elect to exit. It is a different world. Not everyone wants to manage businesses all over the south, the west coast, or the entire country. The PE firm very carefully analyzes the prospective management team in a platform company acquisition. Remember that a PE firm will look to exit in three to seven years from the initial investment, so time is of the essence. In addition to managing the existing business, the platform company management team has to help evaluate potential “add-on” acquisition candidates.

In evaluating all of the CLAMBUS factors, no matter what anyone tells you, cash really is king. It drives everything else. PE firms love a cash machine.

Hard to find any company that is “Litigation free” so, to be correct, I should say “mostly Litigation free”. PE firms don’t want to buy companies that generate risky litigation. A few small lawsuits here and there may not be a problem (but make sure you win them!), but front-page of the paper lawsuits are a non-starter. If losing one lawsuit can destroy a year’s results (or worse, destroy a business), then there are other companies to buy.

Sophisticated business people laugh when they see “Audited financials” since that is an expectation or assumption in the PE M&A world. If you don’t have audited financials, then you really don’t have a company for sale. And don’t have your brother-in-law act as your auditor. He may be great at family get togethers, but he is not independent. You don’t have to hire a Big Four Accounting Firm, but you need a well-respected regional or local accounting firm.

A strong management team is a prerequisite for a platform company. If you are selling your company as an “add on” acquisition, the management team may not be as big of a concern. Some will say a company that is a 1 or 2 on the other six factors must, by definition, have a good management team. That is true, but PE firms look at a potential target’s performance compared to the performance of its competitors. Management is both art and science and PE firms are generally very impressed by the management team that can successfully motivate and manage employees, manage capital and achieve financial results above their peers.

Everyone (other than the government) loves a good business monopoly, but PE firms are particularly careful to make sure that there are some barriers to entry so that the 2,000 pound gorilla can’t come in and dominate the market (unless of course the PE firm is buying the 2,000 pound gorilla). Be the 2,000 pound gorilla in your market or at least make sure no one else is, or can easily become, the 2,000 pound gorilla.

There are very few, if any, completely unregulated markets, but a generally unregulated business is strongly preferred by the typical PE buyer. Not an absolute, but strongly preferred. PE guys are smart and fully understand that anything that is unregulated may become regulated at some point.

Scalable. Scalable. Scalable. Hate to overstate the obvious, but if you want a PE buyer, then your business needs to be scalable so that it has lots of room to grow.

There are of course many other factors that PE firms consider. In fact, every PE firm has their own “secret sauce” that they use in evaluating the various aspects of an investment opportunity. Long-term customers/clients with lots of cash to spend are of course a selling point. I think PE firms love an acquisition candidate that has already acquired and successfully integrated one or more companies. PE firms definitely like an acquisition candidate that has a detailed list of other companies that the acquisition candidate would like to buy (a shopping list, if you will). It shows expansion plans and willingness to face the challenges of rapid growth.

If you are thinking of selling your company and you have a really low CLAMBUS score, call your helpful investment banker (yes, you need an investment banker and yes they are helpful) and get an offering memorandum prepared. You’ve got a company to sell and you will have lots of potential buyers.

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