Private equity (PE) firms specialize in buying, growing, and improving companies, often with the goal of building lasting value. For small and medium-sized businesses, PE can be a powerful partner that provides both capital and strategic guidance. This article unpack show PE firms use buyouts and buy-and-build strategies to grow companies and enhance their market positions.
Private Equity Basics
At its core, private equity is about investing in private (non-publicly traded) companies, making operational improvements, and scaling them to create value over time. PE firms gather capital from institutional investors, pension funds, and high-net-worth individuals and use it to acquire majority or full ownership of businesses. The firm then works with the company to drive value through strategic improvements and, eventually, sells the company for a profit.
Two common approaches PE firms use to grow value are buyouts and buy-and-build strategies, both of which focus on strategic, long-term improvements.
The Buyout Model: Building Value Through Ownership
In a buyout, a PE firm acquires most or all of a company and takes an active role in management. Here’s how they often drive value:
- Operational Efficiency: One of the first things a PE firm does is to look for ways to streamline the business’s operations. This can include cost-cutting measures, optimizing workflows, upgrading technology, and ensuring that all resources are used effectively. The goal is to increase the company’s profitability and cashflow.
- Revenue Growth: PE firms frequently expand a company’s reach by enhancing its sales and marketing efforts. This may involve entering new markets, reaching new customer segments, or launching new marketing campaigns. Improving revenue growth makes the company more appealing to future buyers.
- Financial Restructuring: By restructuring debt or finding more favorable financing options, PE firms can improve a company’s financial stability and lower operational costs. A solid financial foundation not only strengthens profitability but also provides a platform for expansion and reinvestment.
These value creation tactics help make the business more efficient and profitable, and, over time, PE firms look to exit the company through a sale or public offering, often at a significantly higher value than when they acquired it.
The Buy-and-Build Strategy: Growing Through Acquisitions
Unlike a straightforward buyout, a buy-and-build strategy involves acquiring a “platform” company and then making additional acquisitions (known as “add-ons”) to expand and enhance the platform. This approach allows PE firms to create larger, more competitive businesses quickly and economically.
Some key ways PE firms drive value through buy-and-build strategies include:
- Economies of Scale: By combining several businesses within the same industry, a PE firm can reduce costs, such as purchasing, manufacturing, or distribution. With larger purchasing power, the combined company can negotiate better terms with suppliers and access resources at lower costs. This cost-saving tactic is especially effective when the add-on companies operate in the same sector as the platform.
- Geographic Expansion: Buy-and-build strategies often allow for rapid geographic growth, as the platform company can enter new regions and markets through the acquisition of local businesses. This immediate regional presence can be valuable for growth, providing the platform with local expertise and existing customer bases.
- Product Line Expansion: PE firms often look to expand a platform’s product or service line by acquiring companies with complementary offerings. For example, a PE firm might acquire a business that produces components or materials needed by the platform company. This approach adds diversity to the product line, creates cross-selling opportunities, and boosts revenue.
- Vertical Integration: Vertical integration involves acquiring companies at different stages in the supply chain to create a more self-sufficient operation. For example, a PE firm may acquire a platform’s suppliers or distributors, giving the platform more control over its supply chain, reducing dependency on external partners, and increasing profit margins.
Each of these tactics adds value by creating a larger, more competitive business with diversified offerings and improved profitability. Through buy-and-build, a PE firm positions the platform company to be a market leader and an attractive target for future buyers.
Why This Matters for Business Owners
For many small and medium-sized businesses, partnering with a PE firm means gaining access to capital and expertise that supports growth, often at a faster rate than they could achieve alone. PE firms bring a wealth of experience and resources, allowing business owners to scale their operations, enhance profitability, and eventually see a higher return on their lifetime of hard work.
If you’re a business owner approached by a PE firm or exploring options for growth, understanding these strategies can help you determine whether this path is right for you. By aligning your business with a partner focused on creating long-term value, you’re not only investing in the future success of the company but also setting the stage for potentially rewarding outcomes.
