When Selling an ARM Business, Don’t Forget About Private Equity

Michael Lamm

Strategic and ARM industry buyers are not the only fish in the sea to consider when thinking about a sale of your business. Private equity firms have been very active in outsourced business services (OBS) in 2012. We have seen many platform and add-on investments get done this year and I am sure as we approach year-end, there will be a flurry of more deal closing announcements ahead of anticipated capital gains increases.

We recently posted, for public consumption, the Q3 2012 Outsourced Business Services Sector Review, which includes M&A results – if you haven’t checked it out yet, you can download the free report here. The report touches on the amount of deal activity, and the buyers who are making acquisitions in accounts receivable management (ARM), revenue cycle management (RCM) and customer relationship management (CRM). We saw close to $1B in deal value in Q3 2012.

With all of the regulatory scrutiny crossing over to each of the above areas, whether it’s the CFPB announcing their plans with the large participant rule, the continued noise stemming from Accretive’s actions in Minnesota or the continuing debate around the “The United States Call Center Worker and Consumer Protection Act,” private equity is not shying away and are actively pursuing platforms and add-ons.

Private Equity – Rules of Thumb

Private equity will tend to consider platform investments that have at a minimum of $3-5 million of EBITDA. They won’t typically look at a platform investment that is smaller than that but they would consider it as an add-on to an existing portfolio company. In most cases, private equity will acquire a platform and look to exit in 5-7 years. Some have longer hold periods but it tends to average in the 5-7 year exit time horizon.

Other important points to note:

1. An active management team that wish to continue post-transaction, is critical for private equity (they typically do not want to operate the business day to day) when they are considering a platform investment.

2. Some funds may be open to acquiring a minority position, but typically it will be a control oriented investment.

Key Themes Private Equity Tends to Focus On

Private equity tends to look for several key themes as they develop their investment thesis (in no particular order, different firms put more emphasis on some more than others based on their industry knowledge and advisory bench strength) when evaluating a platform investment in OBS.

Market Dynamics – How has the industry faired over the past 10-20 years and how has the company performed through different market cycles? Is the industry becoming more commoditized? How is the company viewed by its clients? A strategic partner or simply another vendor? How have fee rates and services evolved? How is technology being utilized to drive more efficiency? What are the market risk factors?

Sustainable Year over Year Financial Performance – Has the company’s financial performance been up and down like a roller coaster ride? What is driving the volatility or why has the performance been consistent and what road-blocks could be coming up to impact the company in the future?

Seasoned Management Team – A team that has been through good times and bad, but has stuck through it which shows by the average tenure and years in a particular industry. Having made an acquisition with the current team is definitely a plus or one or more members of team have had prior M&A experience. Management is key for private equity as they are not looking to come in and run the platform day to day. They need to feel comfortable that management is in it for the long-term and is ready to help them grow and exit the investment over the next 5-7 years.

Growth Opportunities – Growth into an existing or new market, or the development of a new service offering doesn’t happen overnight and needs to be carefully planned out and always takes longer than expected. Being able to articulate to private equity management’s growth plan along with the capital needed to execute on that plan (airing on the side of conservatism), is usually the best bet.

Compliance, Compliance, Compliance – Since OBS is filled with regulatory concerns, it is important that the company has all of the necessary compliance requirements in place. Private equity is always concerned about PR risk and does not want to end up on the front cover of the Wall Street Journal.

Lower Levels of Client Concentration – Having concentration where one client makes up 20% or more of annual revenues is fairly common and doesn’t necessarily make private equity run for the hills. Like any buyer, private equity and their lenders will want to do a lot of due diligence around that client and the individual who maintains that relationship. The other key client relationships that make up a majority of the revenue will be an important part of due diligence as well. They typically will want to meet/have calls with the key clients (at the tail end of due diligence) and have direct interaction with the main points of contact that oversee the client relationships to determine if any changes are on the horizon and to assure the relationship are in good-standing.

Financial Controls – Having strong financial controls with a CFO or a seasoned controller at the helm of your finance and accounting department will help to increase the probability of a deal closing/funding. Getting the most accurate financial data will be critical for the private equity firm to rely on as well as the lenders that will be financing some portion of the deal.

Current Owners/Management Have Invested into the Company’s Future – It will be clear when private equity walks through your operation, during a site visit, whether you have spent money on technology, operational improvements, etc. If you/they see key areas that need improvement that will require additional investment, this will factor into the valuation they put on your company.

Is Private Equity Right for You?

Take a minute, maybe two if you have time and think about how your business is positioned today and the steps that you would need to take for your business to be viewed as a platform by private equity.  We always say that the more options you have at the time you are ready to execute a sale of your business the better.  Being able to go down the path of considering all buyers, including private equity lets you weigh all the benefits/drawbacks not only for yourself but for those that have been on the long road with you to get to the point of a sale.

Michael D. Lamm advises owners on their growth and exit strategies for Kaulkin Ginsberg’s Strategic Advisory team. Michael can be reached directly from Kaulkin Ginsberg’s Philadelphia, PA office at 240-499-3808 or by email. You can also read his blogs, follow him on Twitter, or network with Michael from his social media page.