One of the many paradoxes in private equity is as follows:
A private equity offer is the most valuable to vendors, yet the lowest priced. This refers to private equiteers priding themselves on being the lowest bidders in a business sale (hence, entering at a low price), but at the same time believing their offer is the most valuable to the vendors.
How is this possible? Through the creation of future value; value in addition to the prima facie purchase price.
The implication is that private equiteers look for deals in which vendors don’t want to sell all of their stock (minority investments). Because, if they do sell down completely, they’ll mostly focus on the purchase price rather than future value creation. Private equiteers generally can’t compete with strategic buyers on purchase price because they don’t have as much access to synergistic value creation. (See this post for my formulaic explanation of private equity versus trade player deals.) So, it helps if a private equiteer can make a case for future value creation.
To recap this post with previous posts, here are the main reasons you’ll witness private equiteers urging vendors not to sell all of their stock (a minority investment in a private equity deal):
Unless the deal is a spectacular standout, a private equiteer will generally move to lower hanging deal fruit if the vendors aren’t willing to remain in the business. This makes sense because if the vendors are fixated on the initial purchase price and there is a likely strategic buyer offering a higher price, there’s little point in wasting time on negotiating the deal.
Of course, this also works well with the fact that we like to invest in businesses in which the managers invest cold hard cash (see my recent post on this topic). This isn’t to say a vendor can’t sell out while new managers invest, but typically it’s less risky if the current vendor/manager stays around with money at risk. With all of this in mind, you can see why private equiteers often prefer minority investments.