Private Equity as a Potential Exit Strategy for an SME

For many SMEs, the idea of an exit strategy may include selling to private equity firms. While there are various ways to exit a business, I believe that partnering with or selling to a PE firm is one of the most effective, especially given that around 50% of all mergers and acquisitions activity is driven by PE firms; and this figure continues to grow.

Private Equity firms currently have trillions of dollars in capital waiting to be deployed, but attracting PE interest requires careful preparation.

What PE Firms Are Looking For

To capture the attention of a private equity firm, your business must meet certain financial criteria. PE firms typically look for businesses that are EBITDA-positive, as this is a key indicator of profitability. The size of EBITDA required can vary depending on the industry, but in general, businesses should have a minimum EBITDA of at least $2 million to $5 million to be considered by most PE firms. However, certain industries may have higher or lower thresholds based on growth potential and market dynamics.

The 30-20-10 Rule

Another important metric that PE firms look at is what is called the 30-20-10 rule:

?? Gross Profit (GP) > 30%: A healthy gross profit margin shows that your business is generating sufficient revenue relative to the cost of goods sold.

?? Overheads < 20%: Keeping overhead costs under control is essential for profitability and efficiency.

?? EBITDA > 10%: PE firms look for businesses with a minimum 10% EBITDA margin, as this indicates strong earnings potential and financial stability.

If these metrics aren’t currently in place, they can often be achieved through streamlining operations, renegotiating supplier contracts, improving pricing strategies or creative financial engineering.

Trading EBITDA-Friendly vs. Cash Flow-Friendly Practices

It’s important to note that PE firms are often more focused on EBITDA than cash flow, so it’s crucial to align your business practices accordingly. This means focusing on trading EBITDA-friendly strategies, such as prioritising CAPEX (capital expenditures) over OPEX (operating expenditures), which can improve your EBITDA by reducing operating costs and shifting investments into long-term assets.

If your goal is to work with or sell to a PE firm, ensuring that your business is trading in a way that maximises EBITDA rather than just cash flow can be a game-changer. At aeXea Capital, we work with SMEs to make this shift, helping them prepare for potential PE involvement.

How PE Firms Use Debt

PE firms typically leverage a combination of equity and debt when acquiring companies, and the debt portion is often calculated based on pro forma EBITDA, which includes projected synergies from the acquisition. This means that if your business is a strong fit for a PE firm, they may factor in future improvements that will enhance profitability post-acquisition.

Valuation and Multiples

When it comes to valuation, EBITDA size has a significant impact on the multiple that a PE firm may offer. For example, businesses with an EBITDA of $2 million to $10 million might receive a multiple of 4x to 6x, whereas businesses with an EBITDA of $10 million or more could command multiples of 7x or higher. These multiples can vary widely depending on the industry and market conditions at the time of sale.

PE Firms and Challenging the Status Quo

PE firms are known for pushing businesses to new heights by challenging the status quo. They believe that complacency leads to mediocrity, and I take a similar approach when preparing businesses for PE involvement.

Conclusion

Partnering with or selling to a private equity firm can be a highly effective exit strategy for SMEs, but it requires careful preparation. By focusing on EBITDA, following the 30-20-10 rule, and aligning your business practices with PE expectations, you can position your company for a successful exit. If you’re considering this path, aeXea Capital can help guide you through the process, ensuring your business is ready for PE interest.

However, if your business doesn’t meet the size or other requirements for a PE deal, don’t worry. At aeXea Capital, we also acquire, consolidate, and improve businesses, helping them reach their full potential through operational enhancements and strategic growth. Whether you’re looking to exit through a PE firm or by working with us, we can provide a tailored solution to fit your business needs.

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