Private equity (PE) firms are increasingly pursuing acquisitions of privately held companies. Selling to a PE firm can certainly have its upsides, but it also has some significant financial, tax and operational implications. Are you and your company well-suited for a PE deal? Here are some key issues to consider.
Let's start by explaining how PE deals differ from traditional third-party sales in structure and intent. In a conventional sale, an operating company or strategic buyer usually purchases 100% of the business and fully integrates the acquisition into its existing operations. The seller typically exits the company — financially and often operationally — at closing.
By contrast, a PE firm rarely buys a business outright. Instead, the firm acquires a controlling interest (typically ranging from 60% to 80%), funds the transaction with a combination of investor equity and debt, and expects the existing owners and management team to retain a meaningful stake. The goal isn't to fold the company into another entity but to grow it, improve profitability and sell it relatively soon, typically in three to seven years.
Because PE firms manage money on behalf of investors, they focus intensely on financial performance, operational efficiency and value creation. After the acquisition, they often install new reporting requirements, strengthen internal controls, and push for rapid revenue growth or cost reductions.
While this can infuse capital and professional discipline into a business, it also introduces new oversight, higher debt service obligations and heightened performance expectations. In short, selling to a PE buyer isn't a clean exit — it's a partnership with a financially driven investor whose return depends on materially increasing the company's value before selling its interest.
PE deals make sense for some businesses. PE firms generally have capital, resources and expertise to support a level of growth that your business might not otherwise achieve. Moreover, a PE sale could net you an additional payment beyond the initial purchase price, because PE firms aren't usually long-term investors. When the PE firm sells, you could receive a hefty payout, potentially earning you more over the long run than a traditional sale.
However, PE might not be the right exit strategy if you need the full sales proceeds upfront or want a clean break. PE deals may include an equity rollover or earnout for the seller. So, after closing, you may still have an operational role and a financial interest in the company, particularly with a rollover.
Even if you're interested in continued involvement, remember that the company will operate as a partnership. After the deal closes, you probably won't have the same degree of control as when you owned the business. For example, a PE firm might take on more debt than you'd prefer. Investors may closely monitor various key performance indicators (KPIs) and require more formal governance. It's also common for PE firms to appoint board members, and they may replace some members of the company's management team with their own personnel. You should obtain an accurate picture of the firm's plans from the outset to avoid surprises after the deal closes.
Additionally, PE firms tend to focus on efficiency and profit margins, often implementing significant cost-cutting measures. For example, although key employees might receive financial incentives to stay with the company after an acquisition, other workers could face layoffs after the deal closes. This situation can create an uncertain, uncomfortable work environment. Consider alleviating stress by negotiating employment contracts for key staff and arranging for severance packages and placement assistance for any terminated workers.
Another consideration is your company's ability to attract PE investors. They generally prefer companies with reliable earnings and transparent financial reporting. When looking for prospective buyers, be prepared to share your financial statements for at least three years. Ideally, your company has audited financial statements, and your CPA has used them to develop financial projections based on realistic, market-based assumptions.
A quality of earnings (QOE) report may be advisable, too. This report provides more detailed information on your company's earnings. For instance, revenue and profits may be broken down by geographic region, salesperson or product line to understand what's making money — and what's not.
QOE reports can reveal operating risks (such as deferred equipment maintenance, bad debts and capacity constraints), but they can also include information that PE firms can use to add value after closing. For instance, a QOE report may be used to identify revenue-building or cost-cutting synergies. Another important metric that may be evaluated in a QOE report is earnings before interest, taxes, depreciation and amortization (EBITDA).
Generally, your company must have at least $1 million of EBITDA to attract a so-called "platform" investment. If your company is considered a platform investment, the PE firm will treat it as a new business, rather than folding it into one of its existing portfolio companies. If you fall under this floor, you might still be attractive as an "add-on" company that will be combined with a platform company.
Other factors that may help attract PE firms include:
Your business also may appeal to PE firms that specialize in your industry or niche or those that are looking for a specific type of company to diversify their investment portfolios.
A deal's tax implications depend on how it's structured, including the price allocation and whether the transaction is a stock or asset sale. As the seller, you might prefer a stock sale to take advantage of the favorable tax rates on long-term capital gains.
However, PE firms customarily negotiate asset sales. This setup gives them (as buyers) a step-up in tax basis, allowing them to depreciate the assets and claim significant tax deductions. But an asset sale could saddle you (the seller) with substantial taxable income. Why? You'd have a carryover basis in the assets without the benefit of depreciation and amortization deductions. And, depending on the operating agreement's distribution provisions, you might not receive enough cash to cover the tax bill. Moreover, some sale proceeds could be taxed as ordinary income.
Notably, it may be possible to structure a transaction with rollover equity to defer your capital gains taxes on that portion of the purchase price until you cash out the equity. At that time, appreciation will be taxed as capital gains, rather than ordinary income.
A successful PE transaction hinges on choosing the right partner. PE firms have different styles, priorities and strategies. Some expect to be deeply embedded in an acquisition's operations, while others prefer less active involvement.
When evaluating PE firms, review their track records with other companies in your industry. Speak candidly with owners of previously acquired companies, including those that failed to meet stakeholders' expectations. You want a balanced view of both the pros and cons of working with each firm before making your final selection.
Be aware, too, that PE transactions take time to execute. In addition to selecting the right buyer, you'll need to conduct due diligence and negotiate terms. These steps can be burdensome while you're still running the company's day-to-day operations.
As you can see, selling to a PE firm can be rewarding — but complicated. If you decide to pursue such a deal, it's essential to assemble an experienced team of financial and legal advisors early in the process. The team can help you prepare your business, assess offers and negotiate the most favorable terms.