What PE Wants: how to make your music or audio company attractive
As a founder, you’ve poured your blood, sweat, and tears into building, scaling, and operating your company. There’s no one else who knows what you’ve been through. The pressure. The travel. The early mornings and late nights. The 3am wake-up-to-scribble-down-an-idea sessions. The investors and creditors. The regulations and laws and taxes and lawsuits and negotiations and decisions.
But you’ve made it. You’ve built something substantial. You’ve done it for a long time. And now, you’re thinking it might be time to let it go. For music and audio company founders seeking an exit, this article is an overview of your likely option paths, and the considerations you should start thinking about and working on to maximize your reward for all the hard work and sacrifice.
What are the ways to exit (sell) your company?
1. Initial Public Offering (IPO) — listing the company’s shares on a public stock exchange. For most music and audio companies, this isn’t the right fit.
Advantages
Access to a large pool of capital
Increased visibility and brand recognition
Liquidity for shareholders
Disadvantages
Significant regulatory and reporting requirements
Exposure to market volatility and investor pressure for short-term performance
High cost of the IPO process
2. Strategic Sale — selling to another company (known as a “strategic”), likely within the industry. This is historically a common outcome, but M&A (mergers and acquisitions) within MI and Pro Audio appears to be in decline.
Advantages
Potential for strategic synergies (“We could put your peanut butter in our chocolate…”)
Immediate liquidity for shareholders
Significantly reduced regulatory requirements compared to an IPO
Disadvantages
Integration of the combined companies is difficult, both in terms of culture and operations
This can result in dilution or loss of your company’s identity and brand
Likely results in layoffs due to duplications among the combined staff
3. Management Buyout (MBO) — the company’s management team acquires the company, likely with external financing. This can go well, and also very badly.
Advantages
Continuity in leadership, operations, and culture
Management is already familiar with the company, reducing transition risk
Disadvantages
Requires significant capital, often leading to high debt service
May face challenges in raising sufficient funds
4. Private Equity (PE) Buyout, a.k.a. Leveraged Buyout (LBO), Alternative Asset Buyout or Alternative Investment Buyout — sale of the company to a private equity firm. This is increasingly becoming THE exit strategy across industries.
YOU SHOULD KNOW: Perhaps the dominant strategy employed by PE firms is called a rollup, in which the firm makes a platform investment in an initial company, and then proceeds to buy add-on (or bolt-on) companies that are complimentary, similar, or even competitors, in the interest of combining them and eliminating redundant staff, products and services, and even brands.
This inorganic growth strategy rapidly increases revenue (by simply adding them together), and increases profitability through cost-containment tactics (which your employees will be worried about).
Advantages
Access to capital and operating expertise from PE firms and their networks
Less regulatory burden than IPO
Potential for significant value creation through operational improvements (organic growth) and combination (inorganic growth)
PE firms have a clear exit strategy and timeline, such as a sale in five to seven years to another PE firm, IPO, or strategic sale (this is important because…)
Disadvantages
You may have limited liquidity until the PE firm exits its investment in your company
PE firms are likely to implement significant changes, including cost-cutting measures, leadership changes, and sunsetting certain products, services, and initiatives (the potential significance of these changes should not be underestimated)
Integration of combined companies is difficult, both in terms of culture and operations
This can result in dilution or complete loss of your company’s identity, brand, culture, and more
Almost certainly results in significant layoffs due to duplications among combined staff
High levels of debt are likely to be used to finance the buyout, increasing financial risk and making debt service a continual operating concern
Why is Private Equity becoming the dominant exit strategy in 2024?
PE might sound like some far-off, esoteric concept that could never make its way into a tiny, sleepy corner of the world like MI and Pro Audio. Don’t be so sure. Ever heard of Guitar Genter, Sweetwater, Fender, Avid (Pro Tools), Mackie, EAW, Ampeg, Martin, Blue Microphones, Native Instruments, iZotope, or Bose Professional? All currently or recently owned by PE firms.
Several factors are contributing to private equity becoming the dominant exit path:
Abundant Dry Powder: There is a significant amount of capital under management in private equity funds that is seeking to be invested. With huge amounts of capital ready to be deployed (“dry powder”), PE firms are actively seeking acquisitions.
Market Volatility: Public markets are inherently volatile, making initial public offerings (IPOs, “going public”) and public company valuations less predictable. This is driving companies to seek the relative stability and expertise offered by PE buyers.
Operational Expertise: PE firms bring substantial operational expertise, helping companies optimize operations, streamline processes, and drive growth.
Longer-Term Perspective (relative to public companies): Unlike public markets, which can be driven by short-term results, PE firms often take a longer-term perspective. This allows for more strategic planning and investments that may not yield immediate returns but are beneficial in a few years, rather than a few months or quarters.
Regulatory Environment: Changes in regulations and tax policy can impact the attractiveness of different exit paths. In some cases, regulatory changes may favor private transactions over public offerings.
How to make your company attractive to PE
To become attractive to a private equity (PE) buyer, companies should focus on several key areas. That’s not to say all these items need to be solved and completed, but these are the areas where you should focus your efforts. These are somewhat prioritized, so those near the top are the most important.
1. Your financial performance is healthy, consistent, and growing.
You can show consistent and sustainable revenue growth.
You have a stable and loyal customer base, with opportunities to grow it and further monetize it.
Strong profit margins and a clear path to further improve profitability through cost management and operational efficiencies.
Healthy cash flow with the ability to generate significant free cash flow (to be able to support debt service).
Reduce existing debt and show a solid plan for managing future debt
2. You have a compelling vision of how their investment will return much more money.
You can explain how, through your company’s better-capitalized existence, ideally combined with changes in customer behavior, technology, markets, or something else will result in a much-more valuable company in roughly five to seven years.
You have a growth strategy, which could include market expansion, product diversification, or strategic partnerships to name a few.
You have a thesis on how, through more-efficient operations, implementation of technology, scale, cost containment, or restructuring, you envision not only revenue growth, but you will grow EBITDA—Earnings Before Interest, Tax, Depreciation, and Amortization—the standard measure of profitability within PE.
3. You are a market leader and/or have a durable competitive moat.
Your competitive position is strong, you have meaningful unique selling points, intellectual property, and/or proprietary tech.
Your company is number one or two in its market(s), and/or you have identified and validated the opportunity to capture additional market share.
4. Your operations are efficient, modern, and repeatable.
Streamline processes and reduce “swivel-chair” activities that can be automated.
Invest in modern technology to enhance efficiency and scalability. This may include adopting AI and other advanced technologies for operational improvements.
5. You have a seasoned and professional leadership team.
You have a competent, experienced, and complete management team. This may necessitate developing, changing out, or supplementing members of your senior management.
You have strong corporate governance practices. Similarly, learning and development, process and reporting design, and outside help may be useful here.
You maintain accurate and transparent financial and operational reporting. This includes detailed financial statements, performance metrics, and business analytics.
You are tracking and reporting on relevant KPIs (or OKRs, or similar systems) that demonstrate the company’s health and growth potential.
You actively identify and mitigate potential risks, including operational, financial, regulatory, and market risks.
6. You’re actively pursuing transformation of some kind.
While your competitors are doing business as usual, you can demonstrate that you have a future orientation.
That might be some amount of subscription or recurring revenue if you’re more of a transactional company,
It could be adding data, metrics, and analytics to your products to enable better, data-driven decision-making,
It might be digital transformation of some kind, such as integrating AI or automation in your business operations, products, or customer experiences
As you can see, the characteristics PE buyers look for in their investments have a lot to do with the ability to innovate and evolve: precisely the practice areas Dan Radin Strategy specializes in for music and audio product companies. Contact us today to start your path toward a life-changing exit.