The Uncharted Territory of Private Equity in Online Business
Updated on March 16, 2020
When we started out eight years ago with sub-5K deals, it was hard to imagine we’d get to the point where we’d sell a six-figure business.
Now we sell six-figure businesses almost every week, and more and more seven-figure deals are making their way onto our marketplace.
Once we hit the $100 million mark in businesses sold, and our deals kept climbing into the millions, we realized we were in the middle of a tectonic shift, showing the growth of the online business world. With that shift comes increased interest, and with that interest comes new kinds of buyers.
Private equity always seemed too big for us. We thought of these investors as billion-dollar behemoths who would never turn their gaze toward smaller dollars in online business. That’s all changing now. Funds of all sizes are waking up to the incredible Return on Investment (ROI) of the online world. The possibility of a near 100% ROI, a real-world outcome we’ve seen as sellers have doubled their investment on our marketplace, is a strong motivation for funds to build their online assets portfolio.
Now that private equity (PE) has taken notice of online business, sellers are in uncharted territory. In an effort to navigate these waters, we’ve set out to define PE at this moment in time and to set the stage for what working with PE will look like. With PE comes more money, faster processing of deals, and incredible deal offers: all exciting options for sellers looking for their most profitable exit.
Let us introduce you to PE in online business and show how you can benefit from selling to the newest league of buyers.
What is Private Equity?
We’ll try to keep the definition of private equity simple, since—let’s be honest—the subject can get dry quick.
Private equity usually refers to investment funds that buy and restructure companies not publicly traded. A private equity investment can be made by a private equity firm, a venture capital firm, or an angel investor. The investors who fund private equity are institutional investors ranging from pension funds, banks, and insurance companies to high-net-worth individuals. PE investment works to expand the business, restructure operations for greater efficiency, or to give the business the financial support needed to develop products or offers.
These investment funds come in all shapes and sizes. Mainstream PE can range from eight figures to billions of dollars. Right now, funds in our space are more in the area of a couple hundred thousand dollars of investment up to a couple million. The landscape here is in flux, as these types of buyers are just starting to come into our industry.
If you’re looking to act more like private equity yourself, check out this video we did on the topic on how online entrepreneurs can mimic what private equity does:
What Does PE Look Like in the Online Business World?
The truth is, we can’t actually define PE in our space at the moment. Since it’s not a mirror image of PE in the traditional sense, and we are in the early days of observing these groups to see how they act in the deal process, we’re creating the definition of PE in the online world as it happens.
Let’s start with defining the terminology that will be used throughout this article.
You will most frequently see private equity or PE used. We’ll also be using funds to imply a similar meaning. “Funds” feels more accurate to what we are seeing at this point because PE is so new to the online business space. Groups of investors pool their money together into a fund to buy a business, which is why we sometimes call them funds.
Amidst all the newness in the terminology, there is a bit of resistance from some of these funds to call themselves private equity, mainly because they don’t feel like true PE (despite operating similarly to PE). In this case, we will be using the term “PE-like groups” interchangeably throughout the article.
Now that we’ve made the proper introductions, let’s talk about why PE-like groups are showing up in the online business world.
Why is PE Interest Growing, and Why Does This Matter to You?
PE and funds are beginning to buy and sell with us because they see the power and speed of a ROI that is near impossible to replicate through other traditional investments.
Smaller funds are realizing the speed with which they can turn a profit on their investment and the vehicle of passive income they can achieve with online assets. They’re able to transform their businesses, incomes, and ultimately their lives with this kind of ROI.
Bigger funds are drawn to online business for unparalleled ROI opportunities and the speed at which they can see their investment working. Many purchased businesses realize much larger leaps in ROI because of how fast things can move with the correct work being done to the asset. Large returns and less time spent waiting to see cash coming in is bringing more funds to our industry. Even without doubling their profit on one business, some funds create a strategy of acquiring several businesses, knowing that with just a few successes in their portfolio, they can be a win for investors.
You might be asking—why should this matter to me?
More and more, PE funds are showing up in our deals. It makes sense: as our deals get bigger, bigger money is going to enter the picture. To put it into perspective, we just hit the $100 million mark in deals sold and 20% of our deals in the past year involved PE or fund-operated groups. These groups are responsible for a total amount of $22,253,944 in sales and come in at an average business selling price of $927,247. That’s a lot of cash.
Why should you be paying attention to this trend though?
These funds come with DEEP pockets. If you understand how they think, operate, and buy, then the chances of you getting a quicker exit on your business at a higher price point are far more likely. Funds are not afraid to deploy capital to acquire a great deal, but that doesn’t mean it’s going to be “easy”.
Let’s look at what these kinds of buyers are looking for so you can gain the upper hand.
What PE’s Investment Strategy Looks Like
Private equity uses all the same business strategies you are likely familiar with, just with more money on the table.
PE was traditionally built on buying distressed assets and flipping them. They see opportunity in a struggling, devalued business that, with the right investment and infrastructure changes, can be made profitable again. This strategy is in line with the mentality of a Flipper Fred; it’s all about seeing opportunities hidden among challenges and knowing how to overcome them and increase a business’s value. (P.S. If you want to know what your buyer persona is you can find out through our quiz here.)
Private equity is closely tied to general Mergers and Acquisitions (M&A), the consolidation of a business and its assets either through one company taking over another entity (acquisition) or joining two companies together into one entity (merger). M&A takes many different forms but a few different tactics have been used by the PE entering our space.
Some PE may look for businesses appropriate for a roll-up. A roll-up merger aims to acquire several smaller businesses in the same market and merge them together into one entity in order to achieve better economies of scale (cost advantages due to more efficient operations). Roll-ups also help to overcome competition in crowded or fragmented markets.
Once a PE firm has developed their portfolio, they will want to strategically acquire complementary businesses. One way to do this is called a bolt-on acquisition. A bolt-on acquisition may be a smaller company that can be added to a larger company within the portfolio to provide quick wins in expanded services, geographical footprint, or supplementary technologies. The smaller acquired company benefits from the new investment by being able to grow beyond their current capabilities.
This is just a quick take on the vast strategies PE employs to grow businesses and their portfolio. Now that you have a sense of how they make money, let’s talk about how they’re structured.
The Varying Structures of PE in the Online Business Space
So far, our experiences with PE have been hard to pin down because the structures of these funds are so different. Each have their own investment strategy, revealing the diverse directions of PE in our industry.
We can’t name names so we’ll give labels for the kinds of funds we’ve worked with. As we dig deeper into PE, these labels will help us share some of the stories and insight we’ve gained from the individual PE-like groups.
The varying structures of funds we’ve worked with:
- Group A – A PE-like group acquiring lots of business at a rapid pace that meet a certain set of criteria, such as a focus on a single type of monetization like FBA. They see themselves as world-class operators for their specific monetization. They come with full teams to handle every part of the deal on their end. They might not call themselves PE, but they are the closest resemblance to a PE firm, with a similar structure and deal team. While we can see what their buying strategy is, we don’t know their exit strategy. Our current impression is that they are in the building phase of their portfolio and may intend to hold the companies for some time before exiting.
- Group B – This group goes after one-off deals that fit the needs of specific investors. They come with strong due diligence on their side so they are certain they are getting exactly what they need for their investors. They’re likely to show up with extremely specific price offers and have the capacity to follow through quickly. They have a CEO, COO, and plenty of analysts to help with due diligence to keep them quick moving in the deal.
- Group C – This group went through traditional fund-raising and is niche-specific; they are looking to buy up businesses in a particular niche to complement each other.
- Group D – This group started as one buyer/investor who now helps others secure businesses for their portfolio. This group goes for a specific type of monetization, like content sites, in different niches and creates different portfolios of similar businesses.
- Group E – Group E goes after businesses in the 100K–1M range because of limited competition in this price range. This group splits the equity of their acquired businesses with their investors. Investors may invest 90% of the capital upfront while the group puts up 10%; the equity will be split in the same fashion. This group has an interesting tactic of avoiding profit-share while a business is in their ownership. All profits get invested back into the business and profit is passed out to the investors during an exit. This group holds companies within their ownership for 3–5 years at a time, which is typical of PE ownership periods.
What kind of deals does PE go for?
What we see most often with PE is a monetization-specific and niche-agnostic approach. On occasion we’ve seen the trend reversed, where a fund builds their whole strategy around complementary assets in a fast-growing niche. Outside of a monetization or niche, funds might be looking for certain performance metrics for their portfolios. They might have tight criteria surrounding SEO and look to build a portfolio of solid SEO performers. No matter which direction their focus swings, their strategy seems to boil down to one thing: expertise.
A group will develop expertise surrounding a specific monetization, for example, and begin to build their portfolio of businesses one by one. After this strategy becomes a success, and they become expert operators or proficient in investing within the monetization, they may build off of their portfolio with strategic investments.
Let’s use an example to show how this works: Group A has extensive expertise in their monetization and have created a successful portfolio of businesses. They’ve proved their investment thesis and showed their investors that they can deliver as the deals they acquire see aggressive growth. In order to realize further growth, they stepped up for the strategic acquisition of a business that was related to the monetization. Acquiring this business would strengthen the operations of the other businesses in the portfolio. The business acted as a tool and brought value to them beyond profit for its strategic leverage. It also added value for their investors and increased the confidence of the investors in the group’s ability to spend their funds.
It’s still early, but the types of monetization PE buyers seem to focus on are FBA, SaaS, and content-driven sites.
While not the only monetization PE is buying from us, we do see a high rate of PE going after FBA businesses on our marketplace. This makes sense because we sell the most FBA out there. With high investment returns, these funds are building tactical portfolios around FBA to capitalize on opportunity and fragmentation in the FBA space.
FBA businesses are sought after because, with the right operational improvements, the business can quickly realize greater profits. Funds like Group E specialize in tackling every step of a business’s operations in order to optimize every step for the greatest efficiency. This strategy has led the group to experience rapid growth, allowing them to buy more businesses and expand their portfolio.
Forward-thinking growth tactics and hyper-optimization are benefits PE brings to a business, but how can a seller benefit from working with a fund? Let’s dig in.
Pros of a PE buyer
Money.
No need to beat around the bush on this. They have money. And they know how to use it.
With great money comes great resources, which differentiates PE from other buyers. Examples of these resources include having an entire team in place to orchestrate every part of the deal. Working with a fund with a full deal team can result in a faster deal process. They know what they want, what they want to pay, and have a process for securing the business.
Group B, for example, has their own strict due diligence process that allows them to come through quickly on their offers. They do all their own research before the buyer-seller call. On that call, they make their offer down to the penny. If the offer is accepted, the negotiation is, for the most part, done. The benefit, then, of a fund buyer is that they have the subject matter expertise and extended team to execute the deal quickly and efficiently.
Having a large pool of capital at their disposal also creates wiggle room for bespoke deal offers. In our deals with Group A, they’ve often asked sellers what they want to get out of the sale. Then they try to form a deal to match. They want to be fair, and they want sellers to like working with them (though this mentality isn’t always the norm, which we will get into later). For one of our sellers who sold to Group A, this looked like a performance-based earn-out that allowed him some level of involvement post-deal and a cut of sales on new products launched. While accepting a lower up-front multiple, the seller was able to earn in the future if the business performed well, which could lead to a higher multiple pocketed down the road.
This kind of deal is reminiscent of larger fund structures in traditional private equity where the CEO gets to stay on once the company is bought out and have a say in how the company is run. It’s a special opportunity to continue on with the business to the next phase of growth that a seller could have never realized without the investment of PE. That’s what makes working with a fund an exciting opportunity for sellers. They have the money and resources to create deals that would struggle to materialize in a smaller deal with less capital.
Cons of a PE buyer
If you want to work with PE, you have to be mentally prepared for an earn-out. This isn’t something sellers love to hear, but it’s the reality of doing business with funds.
Remember, they have investors to please. Earn-outs and structured deals protect the interests of investors and the fund’s ability to deliver on their promises.
Let’s break down the elements of PE deal structures and earn-outs so you can know what to expect:
Capped Multiples
Some groups cap the multiple they will offer for a business to align with their investment strategy. Group A, for example, has a pattern of capping their deals at a 24x multiple for FBA. This is because they are held to the deal structures their investors know and look for. They get nervous straying much outside this general multiple, as a 30x multiple may be looked at as an outlier to the investor and have to be justified. In the case of a high-performing business whose potential they believe in, they might create a performance-based earn-out to justify to their investors the extra pay-out of a higher multiple.
Long Earn-outs
Simply put, PE earn-outs can be long and complex. Each has their own way of creating earn-outs that fit their criteria, which can be daunting to sellers. Using Group A again, they often structure earn-outs based on earnings over 12 months of having the business in their ownership. This is something many sellers are uneasy with as they’re being asked to trust the buyer to run the business well and pay up in a year’s time. But it is still a good and trustworthy option for sellers because this group is a world-class operator who has expertise in running their specific monetization of businesses. Keep in mind that funds tend to have deeper pockets than other buyers, which makes it more likely they’ll pay over the life of the earn-out, all things being equal.
Working alongside a broker creates a safety net in the case of long earn-outs. There are more protections for the seller because the seller can use the broker’s built-in legal assets, templates, contracts, and agreements. If the fund doesn’t pay the earn-out, then the deal can oftentimes be reversed, which is not always the case in a private deal without these protections. This is a big reason why even savvy sellers choose to sell with us: they want to leverage our systems and processes.
Included Inventory
This is a tough one for us because we are set on our policy that inventory must be negotiated separate from the list price. That being said, some PE groups do push to have inventory as a part of their deals. It’s different across the board. Group B tends to pay for inventory on top of the list prices, but Group A tends to negotiate inventory as a part of the deal; they often go for 90 days of inventory up-front.
We’re making predictions here, but we believe we’ll see a push in larger deals to treat inventory as an asset within the offered price as more traditional PE-like funds enter our space. They’ll be looking to add inventory into their cost more consistently, but this might come into fruition more at the eight-figure mark.
Exclusivity Agreements
For these much larger deals, funds ask for an exclusivity agreement allowing them more time to tick extra boxes on the business before sending over the money. They have a series of final checks they will want to do on the financials of the business and will want to complete due diligence on their end.
So you can get a sense of how this works, Group A typically calls their agreements a “term sheet”; what this does is grant them a period of exclusivity. To follow the terms, we take the business off the marketplace, so the group can perform extra due diligence checks with every one of their departments and create their own P&L. After these checks, they make the deal offer. Group A takes the term sheet seriously, so if they do go through and sign a term sheet on the business, they have the full intention of buying that business unless something goes awry.
In traditional private equity, exclusivity agreements can be detrimental to a business. Many larger PE firms will sign away on exclusivity agreements without being serious about following through on the sale, preventing the business from being shopped around and wasting a ton of time. This leads us to our final point that needs to be made—why brokers are a key part of protecting your business in PE deals.
Why Working with a Broker is Key for Working with PE
The emergence of PE is exciting for us and for sellers, but working alongside a PE buyer requires special care. We don’t want this to feel like a sales pitch, but we’ve experienced some real situations where having a broker in the deal was critical for the interests of the seller and the deal as a whole.
In many deals with PE buyers, we’ve seen them come in at the 11th hour with renegotiations on the sale price. The renegotiations are a last attempt to make more money off their investment by lowering the sale offer. This is a frustrating spot to be in for a seller, to say the least. Most sellers aren’t equipped to take on a firm in these tight negotiations, and in every one of these cases, we’ve stepped in to act as an advocate for the seller and fight for their share in the deals.
At the end of the day, PE buyers are out to work for the interests of their investors, not always yours.
Having an advocate, or someone in your corner, during one of the biggest financial transactions of your life enables you to walk away with a deal that protects your financial goals, interests, and dreams.
The asset of having an advocate holds true by not only protecting you in negotiations, but also by helping you design a deal that works for you. We can work with you to create a deal you love and bring that to the offer table to present to high-stakes PE buyers. If your business has a unique value to the fund, we are able to help position your business strategically for its true worth and make sure you are paid for it.
When it comes down to it, working with a broker can help you get the highest multiple possible. Because we shop your business around to multiple buyers (or even multiple funds), you’re able to receive multiple offers and walk away with the best possible exit.
The Future of Online Business and PE
No one has a crystal ball to give us an exact picture of the future, but we can report on what is happening now, and we hear the rumblings of change.
Already we see more and more buyers looking to pool resources to start their own fund and leverage capital for deals they couldn’t have reached on their own. The private equity model is influencing these buyers to combine their resources in a fragmented space.
PE interest is here to stay, if not, increase with time.
If this sparks your imagination, and you’d like to know how your business could make a profitable exit on our marketplace, you can set up a call here to discuss the opportunities with one of our business analysts. If you’re a buyer (PE included!) and want to find your next asset, call us so we can connect you to the right business for your goals or portfolio.
