Should You Take That Call From The Private Equity Group?

December 3, 2014 — Boca Grande, FL

Almost all Entrepreneur Owner-Managers who own mature, private companies receive an unbelievable number of unsolicited letters, calls, and emails from Private Equity Groups and from business brokers who represent them (or are “fishing” for leads of companies to sell). I scratch my head, because I just cannot believe that seasoned, successful business owners have the time to bother to reply to any cold calls or cold letters, but you must, because PEGs persist in doing it! Frequently, if you do reply or speak with these folks, they will quickly make you a verbal offer of a “range of value” for your business, even with little or no information on your specific firm. Naturally, they always intentionally offer far less than fair market value. This makes sense, right? I mean, these PEGS are monopsonists, aren’t they?


What’s a monopsonist anyway?
Monopsony: A market similar to a monopoly except that large buyers, not sellers, control a large proportion of the market and consistently try to drive prices down. Sometimes referred to as the buyer’s monopoly.

In almost all markets in our world, it is customary that an informed seller faces a group of less informed buyers. Understandable, because the seller owns the asset, knows all about what he is selling and the buyers usually have less information because they do not own the asset (yet). Typically, the seller is expected to reveal information about details that will affect all buyers’ interest and valuations, and then the (more) informed buyers make offers. We all know the rules of that game, because we all participate in it, whether we are trying to buy a house, a car, a publicly listed security, or a meal. These are “Buyer Beware” Markets.
But the Private Transaction Market, where Owner-Managers realize their capital gain, is a “Seller Beware” market. Generally speaking, as a seasoned successful Entrepreneur Owner-Manager you are active in the market only once—for the largest single financial transaction of your life. You are genius in your own business domain, but you don’t know the rules of the private transaction market, what is customary, or what is expected. You have little real hard data about the market. Worse, you may be influenced by the narrative fallacies of country club or cocktail party anecdotes. You are Principals in your own businesses, meaning it is your capital at risk—your skin is in the game—and consequently you are subject to emotionally triggered cognitive biases that can negatively influence your decision making.

The investors side of the PTM (whether PEGs or strategic investors) generally have lots of experience in the market—far, far more than you do—after all, they are in the business of making multiple investments. They always have far more information on market conditions than EOM Sellers, and critically, they are Agents, not Principals. Why critical? Since they are not investing their own capital, they have no skin in the game and thus are not susceptible to those cognitive decision making biases. Instead, they can be coldly objective. All perfectly understandable.

Never before in the post-industrial age has there been an extended time when real (inflation adjusted) interest rates are nearly zero, public equity markets are at all-time planetary highs, and corporate acquirers and Private Equity Groups are awash with cash (and seeking private company investments), as they are now. All of these realities favor you, the Entrepreneur Owner-Managers who are trying to build legacy and Enterprise Value. I know you are not objective about this, but in today’s world, what YOU have—a super successful niche private company—is what is scarce and valuable. What the investors have (green, folds, and has George Washington on it) is a relative commodity, and you can basically rent it for the same price from any one of them.

So, you have a significant absolute advantage in the Private Transaction Market. You are expert in your business; your performance validates that. But, PEGS know well that if they can convince you to give away information about your firm—and they know what information will be most helpful to them (and you don’t) — then you are giving away some of your absolute advantage. Most of all, you simply cannot “activate” your absolute advantage in the PTM unless you are dealing with multiple offerers, that is, have “created a market.” In so doing, you level the playing field between EOMs and professional investors by creating a fear of loss and the resulting competitive anxiety among offerers which will bring out fair market value.

Should you take an occasional unsolicited call or even a meeting with a PEG or a strategic investor? Sure, I think you should. Chalk it up to education. Should you sign a Confidentiality Agreement and exchange any formal information? No way. Why would you do that? You are just having a casual conversation and are committed to not giving them any hard information that would require a CA. Instead, do your homework. Prepare a list of questions about what you want to know about them, the businesses they own, the successes or challenges of the management teams that run them. What do they value, why did they call you, why do they find your industry and your business attractive? You can develop a whole portfolio of questions if you have a minute. You might want to ask the (usually young, inexperienced) caller to put a senior partner from their firm on the line. But know this: they are monopsonists, and the Private Transaction Market is a Seller Beware market. You know it is not in their best interest to candidly share their information or experience with you.

That’s why the PEGs and their business brokers are calling you in the first place, right? They are hoping to exploit their experience and information asymmetry. But you know you live in a Seller Beware market. Someday, when you are ready to achieve a capital gain you will carefully create a market of many potential investors, and choose the best fit one. Otherwise, prospective investors will surely take advantage of the impatient or unprepared among us—especially those who don’t bother to “create a market” to attain optimal Enterprise Value.