Ninja Skills: How Private Equity Can Outmaneuver Strategic Buyers

How can private equity firms outmaneuver strategic buyers and get the best companies at (relatively) good prices? Sumeet Shah has some key suggestions.

Strategic buyers, from in-house investment arms of pension funds to large corporations, have been a pseudo-thorn in private equity’s side. They’re flush with cash and thus able to cover any debt that a target company may have. Moreover, their rich networks are flush with synergies for the company to continue growing and expanding their capabilities. It’s why many private companies are continuing to shy away from PE, thereby increasing the amount of dry powder (unused cash for deals) that private equity firms are stuck with.

So the $1 million question remains: how can private equity firms outmaneuver strategics and get the best companies at (relatively) good prices?  Here are some key suggestions, but they require executives to deal with a group they’re not so familiar with: startups.

1. Build a Venture Arm

Some of the most successful venture-backed startups have private equity backgrounds. For example, the plant that fast-growing razor startup Harry’s leased (and ended up buying thanks to an investment from Tiger Global Management) was originally PE-backed. Moreover, Jeff and Andy, the co-founders, both were associates at MA-based Charlesbank Capital Partners along with their close friendship. What all this means is that there’s a lot of positives for PE shops to help their own alumni. PE firms however are tied down by their investment criteria, so how can they invest? As I mentioned before, one shop built a “shell company” to invest $100k-200k in startups with the partial aim to have them grow into the main fund’s investment criteria. The easier way is to pool together partners’ capital.

Now there’s capital involved. Great! But private equity execs can only stretch so far in terms of where to build these relationships. That leads us to…

2. The Accelerator/Incubator Network

We’ve been seeing a recent boom in the rise of accelerators and incubators in the United States. They provide rising startups and companies resources, mentors, and a powerful investor base for them to potentially invest. If you’re new to the area of investing in startups, it’s a great area to start. The big firms, which include Y Combinator, DreamIt, TechStars, 500 Startups, and the like, are relatively welcoming for investors to come into their demo days and are always looking for strong mentors. A good list of them can be found here. I would also refer to my past article on Startups 101 for private equity firms and executives.

Wait, but what does this have to do with outmaneuvering strategic buyers? Because they also send their executives to demo days and as mentors. It’s all about planting the seed.

3. Starting Early = Good Pricing

By starting out early and building relationships (and possibly drop a little capital), PE firms can have strong rapport with startups and younger companies. There’s a reason why some PE shops have better reputations than others (or even the industry in general thanks to the public views of it). Private equity firms’ networks are quite strong as they’re hiring and building up connections with industry veterans, so showing those cards on the table is very attractive to startups. That ALSO means that when the company’s size and financial statistics hit the criteria of your firm, you can then invest and usually get strong terms on the deal. Moreover, if strategic buyers try to come in and drop cash and box you out, you can point to your work in the past and the relationship you built with the company.

There’s a growing trend of organizations with an open checkbook trying to find the next “unicorn” (valuation over $1 billion), and relationships matter so much more than ever these days.

Now the biggest question remains: whose role within the private equity firm does this belong to? Immediate signs point to the Business Development and Deal Origination teams, but to be quite honest, Partners and Managing Director should be the ones building them. Why? Like private equity shops, young companies and startups don’t always have time to take multiple meetings if they’re not entirely certain it will lead to a strong partnership and/or investment opportunity.

Will this advice entirely solve the problem of strategics boxing PE shops out of deals? No, but it’s definitely the right start.

Sumeet Shah

Sumeet Shah works at Brand Foundry Ventures, an early-stage venture capital firm focused in the consumer sector. He has worked in and covered the private equity industry for 5 years and seen the industry transition from the late 2000s financial crisis to its current state. You can find more information about Mr. Shah here or follow him on Twitter at @PE_Feeds.