How Do Private Equity Firms Turn Profits by Buying Small Businesses?

Private equity firms have become increasingly influential through acquiring small businesses. These firms strategically identify potential in smaller enterprises, increasing their value over time. Here are a few examples of how private equity firms turn profits by buying small businesses:

The Role of Private Equity in Small Businesses

Private equity is the provision of capital by investors to privately held companies in exchange for an ownership stake. These firms raise profit from investments such as insurance companies, pension funds, endowments, and wealthy individuals. Buying a small business requires active involvement between the firm and the small business to best strategize a plan to generate profit. In fact, as of September 2023, over 62,000 United States companies were private equity-backed. Here are a few examples of how these private equity firms turn a profit when they buy a small business.

Business Research

Before a private equity firm decides to invest in a small business, it goes through a process of conducting extensive research on the business. Firms typically consider the following factors when evaluating a small business:

• Industry competitiveness
• Potential for growth
• Company strength
• Financial situation
• Management dynamic
• Acquisition

Often, small businesses lack the funds to grow. This is where private equity firms step in. They acquire small businesses by purchasing or taking a stake in them, identifying ones that have room for growth over time.

Operational Improvements

After acquisition, private equity firms work with small business management to pinpoint areas for improvement. Reducing costs, improving efficiency, or investing in new technologies are usually common examples of initial improvements private equity firms aim for.

Financial Strategies

Ensuring a newly acquired business has a solid financial foundation is critical. Private equity firms will refinance existing debt, optimize costs, or restructure equity. With expertise in various financial areas, they guide small businesses from beginning to end to maximize profitability on both sides.

Expansion

Private equity firms focus on small business growth organically and through acquisitions. A firm may invest capital to support expansion into new markets or introduce new products or services. A private equity firm working with a small business management team also ensures direct communication and aligned expansion goals. In a large, public company, there are multiple shareholders. Since investors have a controlled stake in private equity, they are directly involved in the expansion process, making it more efficient.

Management

Private equity firms will bring in highly skilled executives to provide guidance. In doing so, the small business is under trusted expertise in its newly acquired stages. These executives may also train new management teams to improve leadership.

Exit Strategy

Private equity firms plan to exit their investments within a specific time frame, typically between 3 and 7 years. After this time has passed, the small business will hold a significantly higher value compared to its initial investment. By preparing the business for the exit strategy, the firm is confident that the business is well-positioned for future growth or potential buyers.

Profit Summary

Once a private equity firm’s exit strategy has been implemented, it realizes its total profit from the investment. The firm may distribute the capital to all the necessary investors or reinvest in new opportunities.

Looking to Buy?

If your firm is ready to take the next step in buying a small business or simply wants further information, Sunbelt Business Brokers is ready to assist you. Find the nearest Sunbelt office and see how we can transform your buying journey.