For closely held manufacturers looking to finance growth while controlling personal risk by diversifying their net worth, recapitalization through a private equity group (PEG) is an increasingly attractive option.

Why? There’s a lot of private equity capital available. PEGs have gone from closing $35 billion in deals in 1996 to more than $750 billion in 2006. With so much private equity money chasing deals, multiples have trended up. Where PEGs were reluctant to enter deals with multiples more than five times EBITDA (earnings before interest, taxes, depreciation and amortization) just a few years ago, deals above that threshold are now common. At the upper end of the closely held market, entities which might have opted for an IPO (initial public offering) in the past are now looking to private equity buyers to avoid Sarbanes-Oxley requirements and attendant concerns.

But business owners considering private equity recapitalization need to understand what PEGs are looking for—and what they’re looking to avoid.

Unlike traditional strategic buyers—which are focused on complementary customer bases, product lines or other asset-driven values that build a permanent strategic advantage—PEGs are financial buyers. They target businesses they believe can be grown quickly or made more efficient in relatively short order. Private equity buyers are looking to build the value of the business quickly—usually within a three- to seven-year timeframe—and then sell it. Therefore, private equity makes the most sense when an infusion of capital can be tied to defined growth opportunities and existing strategy.

Business owners should also understand that very few PEGs are interested in minority positions—they want a majority stake in the company. PEGs have varying management styles when it comes to their portfolio companies. Some have their own teams of operational professionals that take a direct, day-to-day interest in a company, while others may limit their contact to periodic board meetings. All PEGs, though, set clearly defined performance benchmarks and hold management accountable for meeting them.

What role do you wish to play in the business going forward? Do you want to continue to be an active leader, or are you hoping to dial back your involvement and risk? While most PEGs want current leadership to continue through at least a transitional period, you can find buyers comfortable with a broad spectrum of options for current management.

Family-owned businesses present special concerns for private equity buyers. PEGs prefer businesses with strong, professional management teams. If leaders were chosen more for their family ties than their professional credentials, a PEG may want to make adjustments. For tax purposes, family businesses often structure compensation and benefit programs to minimize taxable income while maximizing what a family member can pull out of the business. While this makes sense in the family context, such a strategy holds down EBIDTA, which means a PEG will most often change this practice. Companies considering private equity recapitalizations should focus on increasing revenue and maximizing enterprise value.

Financial statements can also complicate deals with PEGs. Because closely held companies don’t face the same audit requirements as public firms, their accounting practices are often not as stringent. The less reliable the financial statements, the higher the perceived risk for the buyer—which can drive down value or even keep the deal from closing. Compliance issues aren’t the only concern. Companies with solid activity-based costing and other performance-focused accounting programs afford PEGs the opportunity to more easily evaluate growth potential.

For many manufacturing company owners, private equity recapitalizations answer a variety of needs. They allow owners to continue to finance the expansion of their companies while allowing them to realize some of the value in their business—currently at attractive multiples. They give owners the option of redefining their role within the organization when they are ready to slow down. Finally, manufacturers who establish a successful strategic partnership with a PEG can realize another significant payday for their remaining stake when the PEG cashes out. IBI