Anyone who’s ever attempted to grow a business understands the importance of capital. Organic growth is wonderful but it often occurs gradually. Companies looking to expand at a faster-than-market rate require funding to invest into their operations to create, acquire or uncover growth opportunities.
In the dealer and aftermarket sectors, local banks, vendors and even relatives have long served as common investment partners for business owners seeking an influx of cash to spur their business forward. And while those lending partners still exist, the last decade or more has also seen the proliferation of a lesser-known investment avenue: private equity.
Private equity (PE) isn’t new to the trucking space or economy at large. Investment firms have existed for centuries and their influence can be found throughout world economic history.
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But as specific investment type, PE is a sector on the rise. It’s also a sector that, over the last decade, has taken a keen interest in trucking, particularly the dealer and aftermarket operations supporting the North American fleet.
PE companies see both channels as healthy, mature markets ripe with acquisition or partnership opportunities — and they’re right in that assessment. But despite their status as the newest, most aggressive investors on the scene, experts say partnering or selling to a PE company isn’t for everyone.
If you’re a business owner eager to expand or nearing retirement and looking for the right buyer to sell your operation, it’s important to recognize how PE operations work before entering into a transaction. Private equity can be a fantastic choice for some companies, but the wrong option for others.
Understanding how PE operations transform a company is a good way for business owners to identify if PE makes sense as a potential buyer or future business partner.
What is private equity?
The simple answer is private equity companies are investment firms. These companies raise capital and then use it to invest in or acquire businesses they professionally manage.
Some private equity firms have grown to earn listings on the stock market but most are private, do not offer stock and source their capital from many areas, such as the investment funds of individual investors. What makes PE firms different than conventional business lenders is how their capital is applied to businesses, says John Walcher, president of Veritas Advisors.
“When talking about lending, it’s important to first acknowledge there are two types of capital — debt capital and equity capital,” he says. “A traditional bank is debt capital in that when a borrower takes out a loan with the bank, they still own 100% of their company, they are just now in debt to the bank for the loan.”
Walcher says PE firms don’t work like that. Their capital comes with expectations.
“[PE firms] can take many forms … some are more hands off than others, but when they invest in a business, they are taking material stock in the company,” he says.
PE firms can come in many forms. Walcher says most are smallish operations from a headcount perspective, with a partner who secures funding and makes investment decisions supported by a team of financial analysts, support staff and more. Another PE type, family office operations, work similarly but generally pull funding from a single entity, Walcher says, and gives Mark Cuban and Michael Dell as examples.
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Walcher also notes while venture capital firms (VC) can be defined as PE operations, the title is a misnomer. VC firms look for extremely high-risk, high-reward opportunities and often invest in cutting-edge industries. That’s different than 95% of PE firms, which instead pursue stable, profitable businesses they can grow and expand.
That’s also why PE has turned its attention toward trucking.
The dealer and aftermarket channels are filled with mature, small- and medium-sized companies with established customer bases and revenue streams. A lot of those same companies also are approaching (or have recently executed) leadership transitions, as many founders, owners and executives approach retirement and initiating exit plans. And transitions offer opportunities for investors.
PE benefits
For business owners ready to cash out or successors eager to make their mark, PE’s access to capital is a major draw. Partnering with a PE company can offer businesses a greater influx of capital than available via debt equity investment.
But PE firms don’t invest haphazardly either. Walcher says most have intricated, detailed financial formulas they use to evaluate targets and will not consider a business that doesn’t meet their parameters. He also notes it is EBITDA (earnings before interest, taxes, depreciation and amortization), not profit or revenue, that drives most decision-making for PE firms.
“Most PE companies have a basement you have to be at for EBITDA,” adds Jamie Irvine with Heavy Duty Consulting Group, which provides consulting and business management expertise for companies in the North American aftermarket and partnered with Notre Capital earlier this year.
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Irvine says EBITDA thresholds can vary by firm but adds most PE companies often operate within specific markets or industries, which not only enable them to focus their workforce on a single area of expertise but also can lead to uniformity in investment expectations. He says for business owners in the aftermarket and dealer space, those are the firms to seek out when looking for a capital partner.
“Don’t go to a capital company that specializes in tech for the medical industry,” Irvine says. “There’s a whole group of people whose lane is commercial vehicles, equipment, repair … . That’s a good place to start because they know the business. They can start the conversation with you.”
That expertise also can speed up transactions. Private equity companies are often eager to proceed when they find a good partner and have expertise to move a deal to completion quickly.
And unlike a personal investor or bank loan, PE capital comes with built-in support. Walcher says PE companies have a “fiduciary responsibility” to their capital investors that necessitates investment in their acquisitions to grow profits.
“A private equity company has one objective, to return investment,” adds Irvine.
Which means no one who partners with a PE firm to grow ever goes it alone. Walcher says beyond professional financial management, many PE firms also install boards of directors within their portfolio companies to support business planning and decision-making.
Private equity companies often do not attempt to manage the daily operations of their portfolio companies, Walcher says, but they will exert their influence within those businesses to develop leadership and management teams best suited to reach their goals.
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“None of them want to run the business,” he says. “They invest in people who are presumably great at running businesses and focus on supporting them.”
That’s how Falcon Affiliates does it.
Falcon Affiliates is a family office based investor focused on business-to-business, mission-critical and service-driven businesses that includes 2023 Distributor of the Year winner Tidewater Fleet Supply/TNT Parts in its investment portfolio.
According to Falcon Affiliates’ President and TFS/TNT Chairman Will Krusen and TFS/TNT President and CEO Dale Herold, Falcon relies “on a strong management team to operate the business on a day-to-day basis and focuses on four primary areas: the strategic direction of the company; operational efficiency; capital allocation and investment to support operations and growth; and shareholder governance.”
The duo say Falcon provides TFS/TNT access to capital, strategic planning, operational improvement and expansion plans, talent management and M&A guidance it would not otherwise have, while also using its internal resources to improve the distributor operations “financial and operational discipline for enhanced margins and cash generation.”
PE investment can lead to other resources, too, such as access to products or services that a small business could not afford independently but is provided through the firm. Irvine references business technology software as an example.
“You might get access to something you may never otherwise have access to,” he says.
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And there’s also the cash-out consideration. One common acquisition strategy used by PE firms is a leveraged buyout, where a PE firm borrows the funds it requires to finance a purchase and then uses the assets of the purchased company as collateral against the funding, per Investopedia.
Irvine says a leveraged buyout can be a confusing process for a seller unfamiliar with the tactic but it’s a tried and true strategy for PE firms. It also can lead to a larger windfall for a seller if the PE company succeeds with the business post-sale.
“PE groups employ leverage to get outsized returns,” Walcher adds.
PE drawbacks
But advantageous as it can be for some, partnering with PE isn’t right for everyone.
While private equity brings capital, business resources and financial management expertise, it also brings control. For entrepreneurs who’ve built their companies through shrewd decision making, market expertise and guile, relinquishing executive control to a PE partner or board of directors can be a tough pill to swallow.
“The personality traits that make someone a successful entrepreneur are not always compatible with what makes somewhat a successful employee,” says Walcher. “They want to be a decision maker. They want to be in control. They are willing to take some risk. That’s not the way things work with PE.”
In situations where an owner or executive is staying on with their business, the way in which that executive operates must fundamentally change. Major business decisions can no longer be made independently, and intuition and market foresight alone are not enough to turn business plans into action.
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“The unfortunate truth is PE [firms] are very financially literate and that’s how they tend to manage their investments,” Walcher says. “That can be very frustrating for an entrepreneur who is suddenly on the payroll and may know something is a good decision but doesn’t have the financial backing to justify it.”
Irvine agrees. He says business owners bringing on PE funding to support growth and scale must be prepared to turn over some autonomy to their new partners. They also must be willing to invest in a management team that will support the choices made by the PE-installed board and not lead their departments independently.
He says the good news is if a business is otherwise PE-ready — meaning it meets the financial benchmarks the PE firm views as attractive — “the people component is the easiest fix.” And sometimes that doesn’t even mean turnover so much as restructuring.
Irvine says adjustments to job descriptions and duties can go a long way, as can a few key hires to point the operation in the right direction.
“Sometimes you have to get everybody off of the bus and then the right people back on the bus sitting in the right seat,” he says.
Then there’s the matter of history. PE companies are required to make business decisions in the best interest of their investors — not a company’s legacy. Changes that alter a company’s branding or go-to-market strategy will be made if they are in the best interest of the PE operation, Walcher says.
“If you’re deeply connected to legacy, then I don’t recommend you sell to private equity. I don’t recommend that at all,” adds Irvine.
PE involvement also requires an operational mindset shift. Irvine says many PE firms in the trucking space seek out businesses that have grown almost as much as possible without professional management assistance. And while that management can improve a company’s balance sheet quickly, it also creates new, loftier goals the company otherwise might not have targeted.
“People may find themselves working harder than they did before the [PE] investor came on board,” says Walcher.
“The challenge of improved financial and operational discipline also comes with higher performance expectations for both people and the business. This mindset change can be very difficult for some,” add Krusen and Herold. “Everyone must recognize that we have third-party shareholders who are owners of the company and they rely on the management team and Falcon to build a strong business and grow their investment.”
Lastly, there’s the matter of debt.
A business owner taking out a $50,000 bank loan is only on the hook for that loan (plus interest) to the lender if business stagnates or slows. But most PE purchases bring debt into a business and make the operation collateral against the debt. When PE partnerships work, that debt is paid off as the business succeeds. But when they don’t, companies can be crushed under the weight of the debt.
“It can be very challenging,” Walcher says. “It’s not the right decision for everyone.”
