In recent years, private equity (PE) has emerged as a formidable force in reshaping various industries. Like any owner and operator, there is a wide range of successes and motivations. With its sophisticated investment strategies, private equity has many examples of elevating operational efficiencies and market positioning of the companies which they acquire. Sophisticated investors have also created dynamic opportunities for sellers and competitors alike. This post delves into how private equity's investments have transformed industries. We’ll explore how PE sophistication enhances operations, influences valuations, and the diverse structures available in PE acquisitions. We will also provide some concerns to be aware of when exploring divesting to a PE backed platform.
Sophistication in Operations and Market Positioning
Private equity firms are known for their strategic approach to managing and growing businesses. Put simply, they look to “professionalize” the operation. Their sophistication often manifests in several key areas:
Operational Improvements:
PE investors typically bring a wealth of operational expertise to the table. They leverage industry best practices, streamline processes, and implement advanced technologies. For instance, in the dental industry, PE-backed practices have seen enhancements in their operational workflows, such as optimized scheduling systems, improved patient management, and better negotiations with vendors. When done efficiently, these improvements lead to higher patient satisfaction and increased efficiency. However, any evolution consists of change, and change can be challenging. But every successful business adapts and evolves over time. The challenge for sellers can be the rapid pace of evolution that can come from an outside investor. Remember, no investor will hand off millions of dollars and be completely invisible. PE will only make investments where there is belief that value can be added. Generally speaking, the higher the multiple compared to similar businesses, the more the investor believes they can realize upside. Sellers should ask detailed questions before closing and if sticking around, be ok with the business advancing forward.
Strategic Growth Initiatives:
Beyond operational tweaks, PE investors focus on scaling businesses through strategic growth initiatives. This could include expanding service offerings, entering new markets, or pursuing strategic acquisitions. This also does sometimes include pricing adjustments as well. In the veterinary sector, PE firms have driven growth by acquiring smaller practices and consolidating them into larger networks, thereby creating economies of scale and enhancing market reach. This helped provide coordinated care for pet owners. However, some firms aggressively made up for the pre-transaction below market pricing in a very short timeframe. Despite many situations just getting back to a competitive structure, some were done so quickly that it damaged the practice’s reputation.
Enhanced Marketing and Branding:
Private equity also invests in marketing and branding to boost market presence. This is perhaps one of the opportunities that comes with the greater sophistication and experience of the larger operation. By refining branding strategies and deploying targeted marketing campaigns, PE-backed dental practices have successfully attracted more customers and improved their brand recognition positioning. I’ve yet to meet a business owner upset about providing their great services to a greater number of customers.
Impact on Competitors and Market Dynamics
The entrance of private equity into a market can significantly alter the competitive landscape. Because of all the above mentioned investments, PE investments can destabilize a market previously . For competitors, the PE investment can disrupt a market previously led by small and sometimes unsophisticated operators. PE-backed companies typically have access to greater resources and expertise, allowing them to outpace competitors in operational efficiency, customer acquisition, and market expansion. This increased competition can drive innovation and force other businesses to up their game.
In the Pest Control industry, for example, practices that have undergone PE-backed transformations often set new benchmarks for service quality and operational excellence. PE firms typically bring in sophisticated marketing, training for new services, and satellite enabled route configurators, improving efficiency and the ability to reach more customers. Competitors must adapt to these elevated standards or risk losing market share.
Valuation Implications: The Role of Multiple PE Investors
One of the most noticeable impacts of private equity is on valuations. When multiple PE investors show interest in a single industry or company, it can drive up valuations significantly. This is because competition among investors to secure promising assets can lead to higher offers, which in turn reflects in the valuations of those businesses.
In the dental industry, practices that have been acquired by PE firms often experience substantial increases in their valuations. 2015 was a fulcrum point when PE dental investments sharply increased. By 2018 dental practice valuations were up 200% to 400% what was being previously paid by dentist buyers. This is partly due to the enhanced operational efficiencies and strategic growth initiatives implemented post-acquisition by PE investors. Also, small individual buyers generally lack the sophistication in their valuation assessments, and frequently lean on revenue versus a PE backed buyer who will focus upon adjusted EBITDA, essentially net income. Additionally, advisors like Exit GM drive a competitive process by bringing in multiple bids from various PE firms to push valuations higher, reflecting the increased competition and perceived potential for growth.
Diverse Structures in PE Acquisitions
Private equity acquisitions come with a variety of structures, each offering unique benefits:
Seller Retiring:
In some cases, the seller may choose to retire and exit the business entirely. This is a common scenario in many industries, where practice owners may seek to cash out and enjoy retirement, leaving the practice in the hands of new, PE-backed management. Any sale transfers risk to the new owner and the seller exiting shortly after the transaction is perhaps the most risky for the buyer. Generally speaking, the more time a seller is willing to be involved post transaction, the more they are able to negotiate for a higher valuation. Depending upon role and industry, this increase tends to max out in the 3 to 5 year range.
Joint Venture Partnerships:
Another structure involves forming a joint venture (“JV”) partnership. Here, the seller retains a stake in the local business, partnering with the PE firm to drive future growth. This arrangement allows sellers to benefit from ongoing involvement and shared success. Some PE firms focus entirely on JV partnerships. It is very important to ask questions and understand the structure. The seller will become the minority shareholder, which means the buyer will be able to make decisions. However, with a good advisor and attorney, certain preemptive rights can be given to the seller to protect their position in the partnership. If the seller is important enough for the buyer to desire a JV partnership, then there is less likelihood that the buyer will want to push the seller out. After all, they need that person for a reason. Generally the biggest sticking point in negotiations is how the seller can eventually divest the retained equity.
Equity in the Holding Company:
Sellers might also have the opportunity to receive equity in the holding company (“HoldCo”) established by the PE firm. This provides sellers with an opportunity to participate in the broader success of the portfolio, potentially reaping financial rewards from the overall growth strategy. This generally only applies to sellers who are sticking around and will be involved in the business post transaction.
For a successful and growing organization, the equity is expected to generate substantial returns. If this comes true, even in a moderate sense, it makes it worth significantly more than the individual practice being acquired. Even with high interest rates, the HoldCo equity is more valuable to the buyer than cash.
Despite what some “advisors” and “experts” may tell their clients, the HoldCo equity is not without risk, just like public company shares purchased on the stock market. There are also many different structures for the HoldCo equity. Some have A, B, and C shares. Some have Preferred and Common equity which is not equally distributed. Hopefully seller’s have completed homework and diligence on the buyers. Ask questions about the equity structure, cash strength, and timelines. The best scenario is that all the equity owners are “in the same boat” and generally treated equally at a sale.
Other Financial Opportunities:
Various other structures, such as earn-outs or performance-based incentives, can be negotiated. These arrangements align the interests of sellers and PE firms, ensuring that both parties benefit from the future success of the business.
Conclusion
Private equity's influence on industries, including the dental sector, is profound and multifaceted. Through sophisticated operational improvements, strategic growth initiatives, and enhanced marketing efforts, PE-backed businesses often achieve remarkable transformations. The increased competition and higher valuations resulting from PE investments further underscore the sector's dynamic nature. With diverse acquisition structures available, private equity offers a range of financial opportunities for sellers, whether they seek a complete exit, ongoing involvement, or equity stakes in a larger holding company.
As industries continue to evolve, private equity’s role in driving innovation and growth will remain a significant factor in shaping the future landscape. For businesses, competitors, and potential sellers, understanding these dynamics is crucial for navigating the ever-changing market environment
About Exit GM
Exit GM is a concierge M&A advisory firm that specializes in assisting business and healthcare entrepreneurs.
Exit GM levels the M&A playing field for moderate-sized business and healthcare practice owners seeking to maximize the value of the most important asset. Exit GM supports entrepreneurs to excel on the M&A playing field, whether it is through transacting with a strategic investor, a financial partner, or acquiring additional locations..
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