How Private Equity Can Win the Deal
Updated on March 16, 2020
We’ve often characterized the industry of online business as the Wild West.
The same boundless potential and creation of new norms that marked westward expansion are hallmarks of the online business world.
Sure, some uniformity has blossomed along the way as monetizations crystalized and we hit our own milestone of $100M in businesses sold. But something new is always unfolding. That unknown, or uncharted territory as we’ve called it before, is private equity (PE) in online business.
PE has quietly emerged as a buying force to be reckoned with. PE groups have used our marketplace to transform their portfolios and grow their firms, and they recognize they’ve stumbled onto something.
There’s low competition. A new market with gaps to be taken advantage of. It’s the dream scenario for PE.
Online business is PE’s wild west—or, as PE often calls it, white space.
White Space in PE
The definition of white space differs throughout the business world, but it boils down to untapped potential and pure opportunity.
This is where PE enters the picture.
Private equity loves white space.
Nothing excites a room of investors more than an untapped industry with a pool of money to be made because none of the other big players are playing for the same business.
White space on our marketplace has looked a little like this: a large business goes live, let’s say a $2M eCommerce and FBA business. It’s a solid business with an operations team in place and it’s selling internationally. It’s well-aged and shown consistent growth over its lifespan.
What happens when a business like this gets to our marketplace? Oftentimes they sit. Waiting.
This is not because the business isn’t worth scooping up right away. It comes down to the buyer pool, which isn’t as full at this price range as for a $20K content site.
But that is changing.
Just a few years ago, selling a $150K business was a big deal. We laugh a little about that now. Our perception of a “big deal” seems to shift every few months. We now see buyers enter deals confidently spending $700K to well over $1 million with little discussion and all cash upfront. They see the business they want and they act.
New buyers backed by large raised funds and, high–net worth (HNW) individuals are changing the landscape for businesses in this price range. The competition isn’t fierce yet, though it is increasing, a trickle-down effect of the PE industry as a whole.
Traditional PE has been desperate for new opportunities. According to Bain & Company’s 2019 Industry Report:
“Demand for assets among both corporate and PE buyers is ravenous . . . Fierce competition and rising asset prices continued to constrain deal count—pushing down the number of individual transactions by 13%, to 2,936 worldwide—but total buyout value jumped 10% to $582 billion (including add-on deals), capping the strongest five-year run in the industry’s history.”
The competition conundrum sheds light on PE’s need for creative solutions and for new potential in a constricted market. With valuation multiples on a serious rise in the middle market, it makes sense for PE to explore the lower middle market (starting in the $5 million range) and beyond to sub–$5 million main street businesses for opportunities. This range is where they could gain equity on the upward trend. There has been an increase in spending funds in smaller increments, from $1 to $2 million at a time on businesses, and then going for a classic roll-up: combining several related businesses, streamlining them, and packaging them together to resell to other PE at a much higher multiple. Tactics like these are giving investors the returns they are looking for.
Let’s get back to the white space at hand. Despite increased competition in the low seven-figure range on our marketplace, the field is much more open than the cutthroat competition to execute deals in traditional PE. PE still carries considerable advantage in a deal over a high net worth individual—money. PE can make better deals because they have much better liquidity, which means on high-quality businesses where competition is fiercer, they can outpay the HNW with a higher upfront amount or even full cash deal that the HNW just can’t bid against usually.
It helps that, while the buying pool has increased, the sell-side is rising to match the buying need. More $1–$3 million businesses are being submitted to us, which means you can expect to see consistent options in this price range, so funds can stay targeted in their buying strategy.
Some of the greatest white space on our marketplace falls just under the $1M mark. It’s a sweet spot just under most PE’s buying threshold and just above the average buyer’s budget. If a PE buyer did step out of the norm and applied the same strategy of buying businesses in smaller increments, let’s say six $500K businesses versus three $1M businesses, they could be swift and aggressive about building a portfolio because in the $500K–$1M range it’s the quietest in terms of competition. If the businesses were stacked based on monetization, it would be easy to realize synergies within the group. Whether for portfolio-building or stand-alone assets, businesses in this range hold immense opportunities that most people overlook.
We don’t want any opportunity to be missed, so let’s explore what PE can do to excel in the online space.
How PE Can Win as a Business Acquirer
It’s one thing to talk about white space, but it’s another to actually take advantage of it.
While we can’t give you advice on your individual strategy (you can, of course, call us directly to discuss your buying criteria), we can share how we are watching PE buy on their terms.
And real quick, if you as an online entrepreneur want a way to act MORE like private equity, then check out our video on the topic below:
Private equity is making strides on our marketplace by acting as a strategic buyer.
Strategic buyers approach deals looking to add value to the asset they want to purchase. With specialized knowledge about a particular industry or business, strategic buyers intend to realize synergies. Synergies, which typically include cost reduction and increased revenue, allow the PE firm to make quick wins and build a long-term investment strategy.
We’ve seen PE put on their strategic buyer hats in Amazon FBA deals. These kinds of deals are where PE has been most active, and many groups focus entirely on monetization to build their portfolio. They leverage their deep expertise in FBA to optimize operations and boost profits. Understanding how to create synergies within a particular monetization gives them a competitive advantage over buyers, and it’s why they can scale their portfolios and funds at a rapid pace.
For the funds who aren’t subject matter experts in the online world yet, we’ve seen them reach out to bring the right talent in to fill the gaps. Some PE groups use investor–operator partnerships to balance their skillsets. Or their need for management in place leads them to an adaptation of a search fund.
In a search fund, an MBA grad is paid by PE or investors to find a business to buy. When they buy it, the grad runs the business as acting CEO and has equity in the business. We’re seeing something similar on our marketplace, where an operator with a proven track record sets up a business entity that the PE fund then deploys capital into. Instead of that operator buying one business, like in a traditional search fund, they instead buy several main street businesses and roll them up into the funded business entity.
These partnerships allow PE to do what they do best, which is to provide capital and allow the operator to handle the logistics of running the business and be rewarded with profit-share or equity. This model allows PE to go after businesses they couldn’t have run alone and to stay competitive as a buyer.
Success strategies for PE in the online business industry are limited only by their ability to recognize an opportunity. Strategies include flipping as a means to gain over 100% return on investment and taking advantage of online businesses’ lack of overhead compared to offline businesses.
The most important strategy we’ve seen PE use to date is leveraging a broker in deals. And no, we’re not just saying that because we happen to be brokers.
Why a Broker Makes a Difference in a PE Deal
PE buyers come with skills and experience that make them a powerful presence at the deal table.
Many boast a past on Wall Street, have managed hedge funds, or graduated from the top business schools in the world. This prestige is a blessing and a curse for the deal process.
It’s a blessing because PE arrives at the deal table well-versed on deal acumen. It’s a curse because many of our sellers don’t have the same background, having achieved success in different ways. Many reached their level of business with long hours, a few virtual assistants, and a lot of coffee; their entrepreneurial drive helped them reach their million-dollar business dreams.
When a seller who created their business from scratch with their laptop sits down for the first time with a PE hotshot, they may be intimidated. The seller isn’t always ready to handle the buyer’s questions and demands. The PE buyer isn’t always equipped to deal with a newbie seller. Deal negotiations can get frazzled and messy, disrupting the flow and ease of the process for all parties.
This is an unexpected complexity that has popped up for deals between PE and online sellers, and it’s just one reason working with a broker can be critical to the deal’s success. We’ve served as a bridge in these situations, and we know that we will do so more and more as the valuations of our businesses rise.
By letting us broker deals, PE buyers have tactically used us to grow their portfolios fast. They’ve leveraged what we bring to the table so they can focus on growth and delivering on promises to investors. Some have scaled their funds into the tens of millions, and others have grown their fund operations to 100 employees. They have transformed their purchasing power and their identity as private equity groups.
Here’s how working with a broker has helped our PE buyers win in the online space:
- They are able to leverage the largest deal flow available: Funds face a situation of opportunity cost—should they focus time and resources to source their own deals or seek help sourcing that deal flow? Creating consistent and quality deal flow is difficult. PE firms lean on our marketplace to take care of deal flow for them, so they can optimize the use of their precious time. With the largest available deal flow, our marketplace gives funds freedom of choice and can buy according to their own strategy.
- It’s quicker and easier to purchase through brokers: It’s not uncommon for a large, offline PE deal to take from nine months to more than a year to fully close. That’s light-years in the online world. In order to capture an online business at the right moment, the buying process has to happen faster. PE can leverage faster deal flow and exercise due diligence more quickly on our marketplace than if they source the deal privately because they can skip direct outreach to find and close deals themselves.
- Brokers have clear financial data on listings: Combing through a business’ data, following up with the seller to get the correct data, and making sense of numbers that don’t add up are steps PE can outsource to us. We do the heavy lifting and put all the data in front of them—from traffic analytics to the Profit and Loss statement ( P&L). Some funds build their own P&Ls, though some do not, so this is of great benefit, especially when time is critical.
- Fewer resources needed for due diligence means more resources to grow and scale the purchased businesses: It’s simple: fewer resources spent by the fund on outreach and to vet, negotiate on, and migrate an asset to the fund means more resources can be spent scaling the acquired businesses with the right operators.
- Brokers can criteria match and offer outbound services for funds: A solid relationship with a broker can lead to a more targeted deal flow over time. The broker can find a business that specifically matches a fund’s criteria. This benefit is important for funds looking to realize synergies within their portfolio and have zeroed in on exactly what they need out of an add-on acquisition, for example. Having a broker limits the chance of missing out on the perfect business for a given investment strategy.
- Funds have more buyer protections through a broker: Funds can rely on our lawyer specialized in online business to walk them through every step of the process. With the templates, contracts, and agreement processes already set up to protect all parties in the deal, there is an established path to make sure parties follow the rules. Furthermore, we act as escrow, another legal step we take care of to streamline the deal.
- Brokers provide staff and resource options: Working in the online space since 2011, we have met all kinds of talented people. Working with a broker in the long term can lead to recommendations of operators for assets, which greatly reduces hiring time and costs while shortening the timeline to realize a return on investment.
- Brokers bring subject matter expertise and specialized services: Not every PE group entering this space has online business experience. Many are dipping their toes into this industry for the first time, so leaning on a broker well versed in what to look for in a business makes the buying experience more comfortable and trustworthy. In the case of working with us, every department—vetting, sales, migration, and marketing—step in to help execute the deal. A varied team of experts is there, no matter when you need them.
Using a broker shifts the focus of a PE buyer (or any buyer) to strategy, first and foremost.
Instead of worrying “how do I make this deal happen?” or “how do I find the next deal?” you can instead think “how does this deal fit into my strategy and goals?” or “how can I now grow this business?”.
Those are the questions of a mindset geared toward success.
Looking Forward
Within a matter of months, our PE buyer pool has changed in a drastic way. We are being approached by more and more sellers funded by their own sweat equity–gained, HNW, or backed-by-investor groups. PE is settling into the industry and we are here to help them seize the white space.
Interested in online white space and want to set up a call with our business analysts? You can schedule one here. We can also help sellers who would like to exit their business and plan the most profitable exit, including how best to sell to PE if you find yourself in their price range.
