How a Private Equity Firm Outmaneuvered a Cash-Rich Strategic

Note: The following is a guest post by Axial’s CEO Peter Lehrman. The article highlights key learnings from a recent meeting Peter had with one of Axial’s Members. 

When strategic buyers are flush with cash and have identified an asset that they’ve decided is a must have, private equity firms often talk about how they don’t stand a chance. These strategic buyers, with their lower cost of debt and equity capital and their typically deep operating expertise, often can outbid even the most aggressive private equity firms.  So what’s a private equity firm or independent sponsor to do when facing these deal dynamics?

The other day, I caught up with an Axial Member who recounted to me how he recently beat out a strategic for a middle market acquisition that is right over the plate for his firm’s lower middle market investment criteria.  In the end, the key advantage he had in the negotiation that the strategic couldn’t match was all about the flexibility and upside for the current CEO / business owner.  With a sale to the strategic, the current CEO (who owns the entire company) would have had to sell 100% of the company and likely assumes a middle management position inside a multi-billion dollar organization.  By opting instead to work with a private equity firm, this business owner is able to accomplish a few things that are big priorities for him:

1.  Take some chips off of the table immediately

2.  Roll a bunch of equity (in this case, 30%) into the capitalization table of the newly formed company

3.  Maintain the company’s independence while they shoot to take the company to the next level of scale

If you’re in the private equity business and you’re finding yourself up against big cash-flush strategics, offer the CEO a big equity opportunity (20% or more) tied to great performance in the new entity and you’ll figure out very quickly whether or not you’ve got a CEO who wants to go long versus sell out 100% and go home early.  If they take your offer, you’ve got a legitimate shot at beating out a strategic at a price that still works for you and your investors.  If they don’t, then you probably didn’t want to back them anyway.