From the September 2003 issue of Entrepreneur

Banks may have been quiet over the past nine months or so, and venture capital firms mute for all intents and purposes, but another source of private equity--leveraged buyout (LBO) firms--has started making some noise. Following a strong fourth quarter last year, LBO firms were out wheeling and dealing in the first quarter of 2003, with a total of 119 buyout transactions worth more than $19 billion in disclosed values, according to Thomson Venture Economics. That's a hefty jump over last year's first-quarter tally of 45 deals worth $3 billion. Not bad, considering in 2001 and most of 2002, most mergers and acquisitions departments were playing cards to pass the time.

According to PricewaterhouseCoopers research, increased private equity activity suggests a buyout boom in the second half of 2003. Unlike many VC firms, buyout funds are still raising money and are sitting on as much as $100 billion in acquisition capital, says Bob Filek, a partner in PricewaterhouseCoopers Transaction Services group in New York City. With money to invest and only so many big companies for sale, more buyout firms will be turning an eye toward smaller companies.

Those competing suitors will also include larger buyout firms. Though these firms have traditionally focused only on megadeals, with a limited number of stable, profitable targets on the market, larger funds will be prowling for good buys. And they have the deep pockets needed for small-company LBOs, which tend to have a significantly higher equity requirement as a percentage of the overall purchase price. The result, says Paul Carbone, co-director of the global Private Equity Group of Robert W. Baird & Co., an investment banking firm in Milwaukee, is that "we're seeing very large funds look at deals we would never have seen them look at a few years ago. That's a plus for smaller business."

Even entrepreneurs who weren't considering selling might be tempted by the offers, which are likely to include much better valuations than VCs are offering, according to Carbone. "Nice companies are fetching very nice multiples," he says. "And you're just not seeing that many nice companies in the marketplace." The advantage of the LBO vs. the strategic acquisition is that the business owner can arrange to keep a meaningful portion of the equity, up to 40 percent. "So as an entrepreneur, I take a significant portion of my chips off the table today, yet I still have a portion riding for future upsides when the market returns," says Carbone.

It's also a way to stay in a management position after the company is sold. For the most part, LBO partners prefer to keep a solid management team in place. "They know that no matter how much a buyout person knows, or how much due diligence he does, the person who knows the company best is still the person who founded it and is running it," says editor-at-large Dan Primack, of Thomson Venture Economics, a New York City firm that provides coverage of the private equity industry.

Filek says another option for entrepreneurs not interested in trading in equity position for a salary is mezzanine financing, which allows the investor to convert the loan into an equity investment at a previously agreed-on price. This financing has seen a recovery in the improving private equity market. Charles E. Hord III, a partner at New York City law firm Chadbourne & Parke, believes small businesses may get more attention in those deals as well. "A lot of the smaller companies don't come with the accounting baggage of Worldcom and the like," he notes. And that can be an advantage when putting together a package for lenders.


C.J. Prince is the executive editor of CEO Magazine. She can be reached at cjprince@chiefexecutive.net.