I just returned from a meeting where a company owner discussed selling 60% of his company to a Private Equity Group. At first glance this seems like a bad strategy. The owner gives up control, and 60% of the profits. It is difficult to protect your interests as a minority partner in a closely held business. The new owners can force changes in strategy, operations, etc. and yet the existing owner is still tied to the business. So, why would any owner take an offer in which another entity acquires a controlling interest in a business?
There are a variety of advantages to the existing owner in this deal structure. First, the Private Equity Group that is acquiring the controlling interest is interested in growing the business and exiting in three to five years. They have a track record of successfully growing businesses by bringing additional financing and expertise. If the existing owner retains 40% and sells in three years he can share in that growth. The owner interests will be protected both by the purchase and sale agreement and by the fact that the PEG wants the owner to be motivated and grow the business.
This deal offers the owner, who has the majority of his net worth tied up in the business, the ability to take some chips off of the table and diversify to reduce his risks. It does so, in a way that allows the money that comes out to be treated largely as a capital gain for tax purposes. So, the potential upside may outweigh the dangers of being a minority shareholder in a closely held corporation
Tags: minority interest, private equity, private equity group
Your comments are spot on regarding taking chips off the table and potentially having a second liquidity option at a higher valuation when the PE firm decides to exit. What can be challenging for the private owner is the different expectations of the PE firm as they typically focus strictly on generating high free cash flow to pay down debt as well as require more disciplined reporting and systems in place. This can be tough on entrepreneurs who are used to calling the shots.