In this post I’d like to talk how a typical private equity investor sees market opportunities and thinks about exit strategies and how we evaluate a potential acquisition aligned with an exit.
Private equity group, like any other investment firm, has to perform and return capital to its shareholders. Somewhat more formal and stringent than a typical publicly traded corporation... Pun intended! This triggers a thought process of a private equity investment entry point and its purpose.
Ultimately, when we evaluate a potential acquisition, we have to ask ourselves how far could we take this business so that the next investor has an ample opportunity to grow it going forward. What this means is every investor invests in different stages of a company’s growth. We can take a business from a regional to a national level, and the next group could work on product extensions and international expansion, as an example. This doesn’t mean every investment is made over a certain phase. There are groups that do both – phase investing and longer-term approaches.
Looking at a typical progression of an average consumer goods business, all things equal, it gets launched with a single product, there might be 2-3 flavors but in essence it’s the same thing. Then, as the product and business get more successful, founders come up with more flavors until the growth flattens, as expected. The next logical steps are national or international expansion and product extensions.
The phases of a company's growth and development directly relates to the investor exit strategies.
Think of a business that’s been run by the founding family for 20+ years. In majority of cases, it has a good presence in its home state or region but relatively unknown outside. Our strategy would be designed primarily around national expansion. This means, brand awareness and marketing, organic growth and via trade spend, or acquiring related smaller brands to increase the scale. Ultimately, we’d be looking to professionalize the management and processes in that business, de-risk certain concentration issues (geography/customer) and scale sales of just a handful of SKUs so that it’s ready for the next growth stage.
Going back to the phases of a typical CPG company growth and development –
(A) 1-2 product categories regional success,
(B) National Expansion, and
(C) Product Extensions, and perhaps
(D) Growth via Acquisitions thereafter.
The phases of a company’s growth and development directly relates to the investor exit strategies. The question we ask ourselves is what the next investor would look for in a business when considering making an acquisition. We’d want to take a company from one phase to another and work toward creating tailwinds that would help the next owner to grow the business even further.
Example: back to our 20+ year-old family-owned business. The strategy there was to design the platform built to scale taking the product to a national level. The paths to exit here would be marketing product extensions you could build on the platform and expand internationally. The design here is to make sure the next investor has an ample room for growth that would be priced at a much higher multiple than otherwise.
In more mature businesses with a good scale and known brand, growth doesn’t come as easy. Hence, we see much of growth achieved via acquisitions. In this case, we’re really designing a complementary add-on to a strategic (i.e. a multinational that would acquire it to keep/increase the market share).
After we determined the phase of investment and value creation strategy, the next step is to understand to whom we would transition the investment. The candidates here are strategic investors, other investors and larger funds of funds, or going public. All are defensible paths of transition depending on the targeted phases of growth and development.
-A.G.
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