Selling a business to a private equity buyer

A private equity or financial buyer is not buying a business. They are buying a return on a sum of money, and your business is the instrument that has to produce it. Almost everything that feels strange about the process — the questions about recurring revenue, the insistence that you stay on, the offer that is not all cash at completion — follows from that one fact. This page works it through in arithmetic: how the price is assembled, what a retained stake would have to be worth years later to beat a simpler all-cash sale at a lower headline number, and the size question most pages avoid asking.

What a financial buyer is actually buying

“Private equity” is the label most owners reach for, but the useful category is wider than that. It covers a fund, a family office, a search fund, a group of individuals with backers behind them, and an investment company that happens to own several unrelated businesses. What they have in common is not their size, their name or how they dress. It is their purpose in owning your business, which is the financial return it produces rather than the place it takes inside an operation they already run.

That sounds like a distinction without a difference until you follow it through. A buyer folding your business into their own can own it indefinitely, and can justify the price from what it does for everything else they own. A buyer whose purpose is the return has no group for it to help, and normally expects to sell it again at some point. So the price they can pay today is constrained by a sum they are doing about a second sale, years out, that has not happened and might not happen the way they expect.

The sum itself is not complicated, and it is worth having in front of you before any conversation:

return on the buyer’s money = (what the business is worth at the second sale − the debt still outstanding then) ÷ the cash the buyer put in at completion

Read that as a seller and the whole process becomes legible. There are only four quantities in it, and each one explains a behaviour you are likely to meet:

• What the business is worth at the second sale. This is why every question is about the future rather than the past. Your last three years of accounts matter to them only as evidence about the next five.
• The debt still outstanding. Part of the purchase price is very often borrowed, and in this kind of deal the borrowing usually sits on the business rather than on the buyer. The business then pays the interest out of its own cash. That is why predictable cash matters to them far more than a good year.
• The cash the buyer put in at completion. The smaller this is, the larger the return on it, which is the reason a buyer is interested in any structure that reduces the cash they hand over on day one — including asking you to leave some of your price in the business.
• Time. It is not in the formula above because it does not need to be, but it governs everything. A return earned over three years and the same return earned over eight are different deals to a buyer whose money has somewhere else to be.

None of this is hidden or improper, and it is reasonable to ask about it directly and early. How long do you expect to hold it? Who do you expect the next buyer to be? How much of the price do you expect to borrow, and does that borrowing sit on the company? A buyer who answers plainly has done the sum. A buyer who cannot answer has either not done it yet or is not the decision maker, and in both cases you have learned something useful before you have spent three months on it.

The practical consequence for you is this. A trade buyer is asking what your business is worth to them. A financial buyer is asking what your business can be made to be worth to somebody else later, and how much of that difference they can keep. Those are different questions, they produce different offers, and they produce very different shapes of offer.

Synergies: what a trade buyer can pay for and a financial buyer cannot

The single largest structural difference between the two kinds of buyer is that one of them can pay you for value that only exists after the purchase, and the other cannot.

Take an illustrative business earning £1,000,000 a year in adjusted operating profit. A competitor buying it can remove costs that are duplicated across the two companies — one finance function instead of two, one premises, one set of software licences, one insurance renewal. Suppose that is worth £200,000 a year to them. Inside their group, your business does not earn £1,000,000. It earns £1,200,000.

The multiple and the cost saving above are illustrative figures chosen to make the arithmetic legible, not a quoted market rate. What matters is the shape. The trade buyer has £1,200,000 of headroom between what the business is worth to them and what it is worth to anybody else, and how much of that gap ends up in your price is purely a question of negotiation and competition. The financial buyer has no gap at all. £1,000,000 is £1,000,000, and every pound they pay above what the business earns has to be earned back out of the business itself.

That is not a criticism of either buyer. It is the constraint each of them is working under, and it is why the two processes feel so different from the seller’s chair.

Neither column is the better deal. A headline number is not an outcome, and a trade buyer with a bigger headline can still be the smaller result once the structure, the tax position and the risk of the process itself are all in the same sum. The information risk of the trade route is worth understanding on its own terms, and is covered separately in selling to a competitor. What matters here is that you know which arithmetic the person opposite you is doing, because it tells you which of your answers they are actually listening to.

One more consequence worth stating plainly. Because a financial buyer cannot pay for synergies, there is a floor under how low your profit can be before they can construct any return at all — which is the size question, and the last section of this page deals with it honestly.

The three levers, and which one is cheapest to pull

If the return has to come out of the business, there are only a few places it can come from. Setting them out side by side explains more about how a financial buyer negotiates than any amount of commentary about their motives.

Use one illustrative deal throughout. A business earning £1,000,000 of adjusted operating profit, bought at an illustrative 6×, so £6,000,000. Of that, £2,400,000 is borrowed and sits on the business, and £3,600,000 is cash put in by the buyer. Assume the business repays £300,000 of that borrowing a year, so after five years £1,500,000 has gone and £900,000 remains. Fees, working capital adjustments and any borrowing already in the business are left out so the arithmetic stays readable; a real deal has all three and they are not small.

Now change one thing at a time and look at the equity value at a second sale five years later.

Every figure above is illustrative and chosen to make the comparison clear. Read the last row against the second. Growing the profit by 40% over five years — real work, real risk, five years of it — produces 2.08×. Simply paying one turn less at the start produces 1.96× with no work at all, on the day of completion, for certain.

That is the single most useful thing a seller can understand about this buyer. The entry price is the only lever that pays off immediately and cannot go wrong. Growth might not happen. The exit multiple is decided years later by a market nobody controls. Debt repayment depends on the cash actually arriving. The price paid at completion is the one input that is certain, and it is your money.

This explains behaviour that sellers often read as bad faith and which is usually nothing of the kind. It explains why diligence is so exhaustive: every adjustment they can argue off your profit figure reduces the price by the multiple. On a 6× deal, an argument that £40,000 of your adjusted profit is not really sustainable is an argument about £240,000 of price. It explains why they care which profit measure you are using, which is worth settling in your own mind first. It explains why they will often prefer a structure where part of the price is contingent or deferred rather than a lower headline number — a lower headline is a worse story for them internally, and a structured number moves risk onto you while keeping the headline intact.

And it explains why arriving without your own view of value is expensive. If the first number in the room is theirs, everything that follows is a negotiation downwards from an anchor they chose. Working out your own defensible range from your own figures, before anyone is approached, is the cheapest thing you will do in the entire process. How multiples are applied, and what actually moves one, is set out in valuation multiples, and the underlying method in how to value a small business.

Rolled equity: what you get now against what the stake must be worth later

Here is the structure that catches most owners by surprise, and the one where the difference between the headline and the outcome is largest.

A financial buyer may offer a price that is not paid to you entirely in cash at completion. Instead, part of it is left in the business: you take cash for most of your shares, and the rest is converted into a shareholding in the new company that now owns the business. This is usually called rolling over, or retaining a stake, or reinvesting. It is sometimes described as a second bite of the cherry, because the retained stake is sold again when the buyer sells, which means part of what you get for your business depends on a transaction that has not happened yet and is years away.

Whether that is good or bad is not a question this page can answer, and it does not depend on anything general. It depends entirely on the numbers in front of you. So here is how to put those numbers side by side.

Take two illustrative offers for the same business earning £1,000,000 of adjusted operating profit.

Offer B has the bigger headline by £500,000 and puts £400,000 less in your hands at completion. That £400,000 gap is the whole question, and it is the number to keep hold of.

Now look at what the retained stake actually is. The buyer funds the £6,000,000 purchase like this: £2,400,000 borrowed and sitting on the business, £2,700,000 of their own cash, and your £900,000 left in. Their cash and yours together make up £3,600,000 of equity in the new company, so your stake is:

£900,000 ÷ £3,600,000 = 25% of the equity, in a company carrying £2,400,000 of debt

Notice what has changed about your position. You no longer own 100% of an unborrowed business. You own a quarter of a borrowed one, you do not control it, and the debt gets paid before the equity does. That is not a hidden term; it is the ordinary arithmetic of the structure, and it cuts in both directions, because the same debt is what makes the stake worth a lot if things go well.

Here is the second sale, five years out, in three illustrative scenarios. Assume the same debt repayment pattern as before where cash allows.

Against Offer A’s £5,500,000, those three lines are £1,475,000 ahead, £675,000 ahead and £62,500 behind. Every figure is illustrative; the point is the spread, not the levels.

The more useful question is not which scenario happens but where the line sits between them. Offer B beats Offer A the moment the retained 25% is worth more than the £400,000 you gave up at completion. Work backwards:

£400,000 ÷ 25% = £1,600,000 of equity needed at exit, so value at exit must exceed £1,600,000 + whatever debt is still outstanding

At the pessimistic assumptions in the third row — £1,800,000 of debt still outstanding and a 4.5× exit — that needs a value at exit of £3,400,000, which is profit of about £756,000. Check it: £756,000 × 4.5 = £3,402,000, less £1,800,000 of debt is £1,602,000 of equity, and 25% of that is £400,500. Just past break-even. So on these illustrative numbers the business could earn roughly a quarter less than it does today, sell at a materially lower multiple, and the structured offer would still have matched the simpler one.

That is the honest shape of it, and it is why the arithmetic is worth doing rather than reasoning about the structure in the abstract. It is also why three further things belong in the sum, none of which this page can do for you:

• Time. £1,875,000 in five years is not £1,875,000 today. The comparison above is deliberately shown in plain pounds first, because that is the version both sides will quote. Discounting it for time, and for the fact that one number is certain and the other is not, is a separate calculation and it changes the answer.
• The terms attached to the stake, which are not in any of the arithmetic above. Whether the buyer’s equity gets paid back before yours does. Whether your percentage can be reduced if more money goes in later. Whether you can be required to sell when they sell, and whether you can insist on selling on the same terms. Whether there is any route to your money if they simply hold it for ten years. Two stakes described as 25% can behave completely differently, and the difference lives in the articles and the shareholders agreement rather than in the offer letter.
• How the rest of the price is paid. A retained stake and a performance-linked payment are not the same instrument, although both delay money. If part of your consideration depends on hitting targets rather than on a later sale, that is a different mechanism with different failure modes, worked through in earn-outs.

Run the same three-scenario table on your own figures, with your own offers in it, and the conversation stops being about which number sounds bigger. Nobody can tell you which of those columns you should prefer, and this page is not trying to: the arithmetic is the arithmetic, and what you do with it is a decision for you, your solicitor and your accountant.

Why they want you to stay, and what they look at hardest

Sellers often expect a financial buyer to want them gone, and are surprised to find the opposite. It follows directly from the formula in the first section. The buyer has no operation to absorb the business into, no management bench sitting idle waiting to be deployed, and a return that depends on the business performing for several more years. The people who currently make it work are therefore not an overhead to them. They are the asset being bought.

So the structure is usually built to keep those people in place and pointed the same way: a service agreement for a defined period, a retained stake or a performance-linked payment so that your outcome moves with theirs, and often an incentive arrangement for the management team below you as well. What they are trying to buy with all of it is continuity, and the continuity they most want is of relationships and knowledge that are not written down anywhere.

Which leads to the three things they examine harder than anything else, and to why each one matters specifically to this kind of buyer.

There is a trap in the owner dependence question that is worth naming. The more indispensable you are, the more the buyer wants you locked in, and the more of your price they will want to make conditional on you staying and on the business performing. Being essential does not raise your price. It moves your price into instruments you only collect later.

As for what happens to the business afterwards, the honest answer is that the mechanics are fairly predictable even though the experience varies enormously. Reporting gets faster and more formal, usually monthly, usually to a fixed pack, because the investor has their own reporting obligations. A board appears, or the existing one starts meeting properly, with at least one seat belonging to the buyer. There is a plan with numbers in it that someone is measured against, and that someone may be you. Decisions above a threshold need approval, and the threshold is written down. Spending patterns change, sometimes towards investment and sometimes towards cash generation, depending on what the plan says. Some buyers buy other businesses to bolt onto yours. And at the end of it there is another sale process, which is the event the whole structure was built around.

Whether that is welcome or intolerable depends entirely on the owner, and it is worth being honest with yourself about it before the process starts rather than eighteen months into a three-year service agreement. An owner who wants to hand over the keys and go is describing a different transaction from the one this buyer is offering. That is not a reason to rule the buyer out, but it is a reason to say it out loud early, because it is much cheaper to discover in the first meeting than in the completion documents.

Is your business big enough, and what to do if it is not

Most pages on this subject flatter the reader. This one will not, because the size question is the first one to settle and the answer decides whether anything else on this page is relevant to you.

The work involved in a financial buyer acquiring a business is broadly fixed. Commercial, financial and legal diligence. A model. An investment committee, or its equivalent, that has to be persuaded. Lawyers on both sides. A funding package. Then someone attending board meetings for five years. That workload does not shrink very much when the business does, because the same questions have to be answered about a small business as a large one.

Put that against the gain. Return the illustrative deal to the table, and run it at two sizes with everything else identical — same structure, same 6× in and out, same proportion borrowed, same doubling of the money over five years.

Illustrative figures again, but the ratio is the point and no choice of figures changes it. Identical effort, identical risk of getting it wrong, and one column produces nearly seven times the gain. That is why a size threshold exists. It is not snobbery and it is not about your business being a poor one. It is arithmetic about where a fixed amount of work is best spent.

So: if your business earns tens of thousands rather than hundreds of thousands, this page has been describing a buyer you are unlikely to meet, and it is better to know that now. Where exactly the threshold sits varies enormously between buyers and there is no universal number, so the useful move is to ask any buyer directly what size of business they invest in before you spend three months preparing for them. A buyer who does this for a living will tell you immediately, and will not be offended by the question.

That is not the end of the road, it is a different road. Businesses below the threshold are bought all the time — by individuals buying themselves a job and an income, by a trade buyer who wants the customers or the capability, and by the people who already run them, which is worked through in a management buyout. Those buyers have their own arithmetic and it is not the arithmetic on this page.

If a financial buyer is the route you want, the list of what makes a business attractive to one falls straight out of everything above. There is nothing surprising on it:

• Revenue that repeats without being re-won. Contracts rather than habits, and the paperwork to prove it.
• Profit that can survive a debt repayment schedule. Stable margins beat a good year, and a good year followed by a poor one is worse than two average ones.
• A management team that runs it without you. Not a plan for one. An actual second tier who already make decisions, and who the customers already know.
• Customers spread widely enough that losing the largest is a bad quarter rather than a crisis.
• Accounts that are clean, timely and reconcile to the bank. Management figures that turn out to disagree with the statutory accounts cost more in price than the amount in dispute, because they make every other number you have given suspect.
• Somewhere obvious for the business to grow, and preferably evidence that you have started and it worked, because their return needs that growth to exist.
• Processes that live in documents rather than in people’s memories.

And if the business does not look like that today, the options are genuinely only two, and both are respectable. Do the work, which realistically takes two to three trading years because the evidence has to appear in the accounts rather than in a presentation: move customers onto contracts, hand relationships to named people who are not you, fix the reporting, reduce the concentration. Or accept that your buyer is a different buyer, and run a process aimed at the one you actually have rather than the one the internet talks about most.

Either way the first step is the same, and it costs nothing. Work out what the business is worth on your own figures, from your own profit measure, before anyone else puts a number in front of you — the free business valuation calculator gives you a range in your browser, and how to value a small business sets out the method behind it. A seller who knows their own number is not harder to deal with. They are simply harder to anchor.

Arithmetic and general information only — not financial, tax, legal or investment advice. Your own figures, and your own accountant, decide what any of this means for you.

Frequently asked questions

What is the difference between selling to private equity and selling to a trade buyer?

A trade buyer already runs an operation, so the business is worth more inside theirs than it is on its own: duplicated costs disappear and customers they were competing for become theirs. They can pay for some of that extra value. A financial buyer has nothing to merge the business into, so the return has to come out of the business itself through growth, through better margins, through repaying borrowing, or through the price and structure of the deal.

Is my business big enough for a private equity buyer?

Often the honest answer is no, and it is better to know early. The diligence, legal work, modelling and years of board attendance involved are broadly the same whether the business earns 150,000 pounds a year or a million, while the gain in pounds is many times larger on the bigger one. That is why a size threshold exists. Where it sits varies a great deal between buyers, so ask any buyer directly what size they invest in before spending months preparing for them. Below that threshold the realistic buyers are individuals, trade buyers, or the management team already running it.

What does it mean to roll over equity when selling to private equity?

It means part of your price is not paid in cash at completion. Instead it is left in the business and converted into a shareholding in the new company that now owns it, which is sold again when the buyer sells years later. So part of what you get for your business depends on a second transaction that has not happened yet. The arithmetic to run is simple: how much less cash you receive on the day, and what the retained stake would have to be worth at that second sale to make up the difference.

Why does a private equity buyer want the owner to stay?

Because they have no management team to drop in and no operation to absorb the business into, and their return depends on it performing for several more years. The people who currently make it work are the asset being bought. That is why the structure usually includes a service agreement, and often a retained stake or a payment linked to performance, so that the outcome for the seller moves with the outcome for the buyer.

Why do private equity buyers care so much about recurring revenue and customer concentration?

Because part of the purchase price is commonly borrowed and that borrowing normally sits on the business, which then services it out of its own cash. Revenue that arrives without being re-won each month is what makes those payments safe, and it also supports more borrowing, which reduces the cash the buyer puts in and raises their return. Customer concentration is the mirror image: one customer at forty per cent of revenue is a single point of failure sitting directly in front of a repayment schedule.

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