7 Questions to Ask When Competing with Private Equity

Outbid by Private Equity? 7 Questions to Ask Before You Pay More for a Business

You find a good small business. You analyze the numbers, decide what you can reasonably pay, and make an offer.

Then another buyer—maybe a private equity group—comes along and offers substantially more.

Did you lose?

Not necessarily.

The collapse of Renovo Home Partners provides a useful lesson about what can happen when acquisition prices, leverage, operational assumptions, and market conditions combine to create a fragile business.

Renovo was a private equity-backed roll-up of home improvement businesses. Public reporting described a network that eventually included 16 affiliated subsidiaries operating in at least nine states. The business ultimately entered Chapter 7 bankruptcy, leaving employees, customers, lenders, and other creditors dealing with the consequences. Pasted text

We don't have enough public information to know precisely what caused Renovo's failure. But the case provides a useful framework for any small-business buyer who finds themselves competing against an aggressive bidder.

Why Can Private Equity Pay More for a Small Business?

A roll-up typically involves acquiring several similar companies with the expectation that the combined organization will become more valuable and efficient.

The buyer might expect centralized marketing, purchasing power, shared management, consolidated customer service, better financing processes, or other economies of scale.

In other words, they're not necessarily valuing the company based only on what it is today.

They're also valuing their plan for what it could become.

That can support a higher offer—but only if those assumptions actually work.

“Being the highest bidder sometimes just means that you're assuming the rosiest future.”

Individual buyers make the same mistake. They justify a price based on improvements they expect to make after closing: new software, better marketing, improved management, higher prices, lower expenses, or some other supposed efficiency.

Those improvements may happen.

But you shouldn't confuse something you hope to create with something you're buying from the seller.

1. What Happens If Revenue Drops 15% to 25%?

Stress-test the acquisition before worrying about whether somebody else will outbid you.

What happens if sales fall?

Small-business revenue doesn't necessarily move upward in a straight line. A highly leveraged acquisition can become extremely uncomfortable after a relatively ordinary decline in sales.

Debt payments remain.

Equipment still needs maintenance.

Employees still need to be paid.

If a 15% decline means you can no longer pay yourself, reinvest in the company, or comfortably service the acquisition debt, you need to understand that before closing.

2. Does the Business Depend on Customers Getting Financing?

Some businesses have derivative exposure to credit conditions.

A home improvement contractor, automobile-related business, or seller of other expensive products may depend on customers obtaining financing.

The company itself doesn't have to lose access to credit for this to become a problem. Its customers can lose access.

That introduces a risk controlled partly by lenders, interest rates, household finances, and broader economic conditions.

The same principle applies to acquisition structures involving balloon payments.

You shouldn't casually assume that because refinancing is available now, you'll qualify for it several years from now.

3. Are the Supposed Synergies Actually Realistic?

A roll-up strategy often assumes efficiencies from combining businesses.

But businesses operating in different locations may face different regulations, licensing requirements, payment practices, labor markets, customer expectations, and competitive conditions.

Centralizing something doesn't automatically make it more efficient.

If you're evaluating an acquisition because you believe you can make substantial operational improvements, ask specifically:

What am I going to change, how much will it cost, how long will it take, and what evidence suggests the improvement is achievable?

4. How Much Customer Deposit Liability Is on the Balance Sheet?

This is particularly important for contractors and other businesses that collect deposits before completing work.

A customer deposit isn't necessarily revenue.

“When you take a deposit from someone, it should appear on your balance sheet as a liability. You're borrowing money from your customer.”

That distinction matters enormously when determining the working capital requirements of a business.

Poor bookkeeping can make it difficult for a buyer to understand how much work remains to be performed against money already collected.

You need to understand not just the company's assets, but the economic obligations attached to the money sitting in the business.

5. How Founder-Dependent Is the Business?

Founder dependency isn't limited to customer relationships.

In a skilled trade, the owner's relationship with employees may be just as important.

Maybe the foremen were trained by the owner. Maybe experienced technicians remain because of personal loyalty. Maybe the seller is the person holding the team together.

If those people leave after the acquisition, your ability to deliver the company's product or service can disappear remarkably quickly.

Ask what the owner actually does—and what could leave with them.

6. What Is the Integration Plan?

If your valuation depends on integrating the acquisition into another operation, the integration plan needs to be more than a spreadsheet assumption.

Think through systems, employees, brands, suppliers, management, customer service, accounting, marketing, and operational processes.

Which systems will change?

Who will manage the transition?

What will it cost?

How long will it take?

What happens if integration takes twice as long as expected?

The more things that have to go right simultaneously, the more fragile the transaction becomes.

7. Are You Buying a Business—or Gambling on Your Forecast?

This is the most important question.

A buyer's goal should not be to win an auction.

I learned this lesson in a much more literal auction when my son was young. He wanted me to keep raising my paddle because he wanted us to “win” the item being auctioned.

I had stopped because the price had already gone beyond what I was prepared to pay.

My answer to him was simple:

“We're not winning if we pay too much.”

The exact same principle applies when buying a business.

Private equity may have access to more leverage, investor capital, or transaction structures unavailable to an individual buyer. That doesn't mean you should imitate their economics.

An individual buyer may also personally guarantee substantial acquisition debt. That makes an overly optimistic transaction particularly dangerous.

Your advantage isn't necessarily access to the most leverage.

Your advantages can be focus, discipline, industry knowledge, operational experience, and the willingness to walk away.

Getting Outbid Doesn't Mean You Lost

One of the hardest things about searching for a business is spending months investigating an opportunity only to see somebody else offer more.

The natural response is to ask, “How can I compete?”

Sometimes you shouldn't.

A higher-priced offer may include contingencies, seller financing, equity rollovers, or other terms that make the headline price less straightforward than it appears.

In other situations, another buyer simply may be prepared to take risks you aren't willing to take.

“If you get outbid by private equity, don't assume that you lost. You may have just avoided inheriting a time bomb.”

Buying an existing business is supposed to give you advantages over starting from zero.

If you overpay, maximize leverage, and create a company that can only survive when every assumption goes right, you can eliminate those advantages yourself.

Discipline isn't losing the deal.

Sometimes it's the thing that keeps you available for the next one.

Want Help Analyzing a Business Before You Buy?

If you're evaluating a business and need help understanding the financials, risks, financing, valuation, or potential deal structure, ALP's Business Investment Analysis services can help you examine the opportunity before committing to the transaction.

Learn more by signing up to our Business Buyer Advantage: Online Training, including the new bonus module at www.BusinessBuyerAdvantage.com