Seller versus Private Equity Fund Valuations and Negotiations

5 min readJul 30, 2020

For private equity companies to make a better return for their investors. Target companies should be purchased by them at a price that lets them achieve a certain hurdle rate. As mentioned, venture funds often make investments in new companies that might have limited revenues. While private equity firms seek out more established companies that have lengthy revenue, if not a profit, history.

It is possible for private equity firms to think that a target is poorly managed. So when this happens, there might be a hap between the value that the firm thinks it can achieve through a new management installation team. And the enactment of certain necessary changes in company operations. And the current value of the target based on its unadjusted future cash flows. This discrepancy might offer the basis for some flexibility in deals and allow for an agreed-on price.

Risk-adjusted Present Value of the Company’s Cash Flows

On the other hand, if the target is managed properly and both parties know of the risk-adjusted present value of the company’s cash flows. Then it is less likely for the seller to be provided with the full value of the company while still letting private equity buyers make great returns on investment. For instance, in 2006, the Salt Lake City-based Huntsman Corp. A $13 billion industrial company, broke off negotiations with private equity firm Apollo Management LP. Huntsman. It lost its money in 2005 and could not negotiate well with Apollo at a price that private equity firm thought makes sense.

The same case was experienced by the grocery store chain Albertsons who could not agree with various private equity buyers, causing bidders to back out. Later the same year, a deal was struck with an investment group to sell the company for a revised price of $10.97 billion. Sellers who wish to sell their companies to private equity firms have to willingly accept a price. That will let these firms make more room to generate a return with another sale of the business in the next years to come. Even if making valuation mistakes is inevitable, private equity buyers still tend to be careful. With regards to overpaying since their gains principally come from the difference between their purchase price and an eventual resale price. As well as money received from the company way before the resale.

Deals Outside Auctions and Proprietary Deals

Dealmakers like investment bankers might represent a potential seller who is looking for a clean and smooth sale and is not interested in a very public auction process. Usually, these dealmakers approach private equity firms and represent that they have a proprietary deal that the private equity buyer may be interested in. But when the potential seller is a public company, this deal might only be temporary since Revlon duties should be considered. M&A laws and the time when an auction is required are all the expertise of private equity firms.

Still, during times like when a founder who holds considerable equity in the company wants to sell in a quick and smooth transaction. Such deals may be more appealing to private equity firms. But deals outside auctions are usually the clear minority. As previously mentioned, there can be a competitive bidding process occurring. Even way before the public announcement of the potential sale of a firm and the start of the formal auction.

Private Versus Public Deals

The usual deal when it comes to private equity business is large-scale, going-private, and involving a public target. Although that is essential in the private equity business. More common transactions are actually private deals that involve acquisitions from founders of businesses. Some are from other sponsors or venture capital-sponsored firms.

Private sellers, especially closely-held founders are becoming prevalent, and it has provided private equity buyers with increased risk. One possible reason is that most of these include a survival clause. A survival clause indicates that the representations made by the seller may survive for only a limited time after the closing period. These clauses are more normal in acquisitions of public companies that worked in compliance with US securities laws. And the penalties posed for false financial disclosures throughout the operation of the company. Meanwhile, when it comes to private companies, many concerns in terms of the reliability of the data in the seller’s financials may occur.

For buyers in 2011, survivability clauses became a bigger concern since the Delaware Chancery Court decided that the survival clause is a kind of law. That limits the ability of the buyer to push through with breach of contract claims. New York, California, and other states, however, have not agreed with their view of how limiting these clauses could be.

Insurance Carrier

Now, brokers of insurance like Marsh McLennan are aware of the characteristics of these policies. That buyers want and are now creating and pricing them. This is due to the newfound demand from private deals. Moreover, these insurance companies which brokers work with have paid out claims. In that way, buyers of policies are more assured with the thought that if they have a problem and need to rely on their insurance, it likely will pay. For bigger policies, buyers will have to syndicate the policy. And include various insurance carriers to bind the level of insurance they require.

In Europe, survival clauses are really common and management, which has some equity in the deal, may bear this obligation. Meanwhile, in the US, when managers realize that after the deal goes through. They will have a new employer, and there is a tendency that they make their own relevant disclosures. Or tone down aggressive representations made by the seller so they won’t have the bosses they don’t want.

Reverse breakup fees are also commonly used by sellers in agreements with private equity buyers. This helps create an incentive to ensure that the buyer convinces the bankers to give the needed debt capital to complete the deal.