How private equity firms fuel a successful future for service businesses.
The “buy to build” philosophy behind private equity investments can yield outsized returns, especially in industries like business services where organic demand translates into top-line growth. With the right combination of capital and expertise, private equity firms can leave an imprint on business operations that remains long after their exit.
In this blog post, we review the many ways private equity adds value to a business, and the unique opportunities for business service owners partnered with private equity firms. We also examine successful case studies to see the transformative potential of private equity at work.
Private equity 101
The term private equity (PE) refers to investments made in companies that are not publicly traded. The capital for private equity investments is organized into private equity funds raised through outside investors. Flexible PE investments, ranging from small growth capital to full buyouts, are open to accredited investors or high net worth individuals.
PE firms have diverse responsibilities that span from pre-acquisition to exit, all with the underlying goal of maximizing ROI. They often accompany investments with operational and financial advice, improvements aimed at increasing the profitability of the company, and ultimately the value of the business when they exit. A few key steps in the typical PE lifecycle include:
● Raising capital: Acquiring commitments from external financial institutions, limited partners, or their own internal assets.
● Sourcing businesses: Finding potential companies to invest in and evaluating their products, services, financial performance, and management teams.
● Due diligence: A deeper dive into the company culture, valuation, and risk factors to ensure the PE acquisition makes sense.
● Deal closing: Business and legal agreements are drawn up and signed so the deal can be completed, and funds can be released.
● Ownership phase: The PE firm puts their experience and expertise to work to improve business operations and profitability over time.
● Exiting businesses: The private equity firm resells the business (or the portion they own) after spending several years optimizing the value.
How PE adds value to a business
The private equity meaning extends well beyond dollars and cents, and it begins with an influx of capital. While this generally refers to the financial capital used to invest in infrastructure, marketing campaigns, or whatever is needed to grow the business, capital also includes social capital stemming from positive relationships and interactions, and human capital based on industry knowledge and experience.
PE backed businesses benefit from an infusion of human capital when the private equity firm provides guidance through their individual experts, including operations and marketing leaders. Successful PE firms often seek out investments in businesses within an industry or niche that aligns with the firm’s existing portfolio, strengths, and expertise.
Social capital comes into play when PE firms leverage their broad network of industry contacts to help grow the business. Networking prowess and industry connections are also valuable when it comes time to find potential buyers and exit the business.
The importance of innovation and scalability
One result of taking a firm private is regaining the freedom to invest in new products, services, or ideas without risking backlash from profit-conscious shareholders. A continued focus on innovation helps to open up new market segments, enhance operational efficiency, or launch new products and services that differentiate businesses from competitors and help them expand.
Scalability is another avenue for PE firms to add value through strategic investment and planning. The combination of capital, operational expertise, and strategic guidance gives PE backed businesses the tools they need to achieve their growth objectives in a controlled fashion. PE firms might also acquire complementary businesses to diversify and expand the customer base.
The opportunity for PE in business services
Companies in the business services sector provide support services to other businesses such as software, security, training, legal, cleaning, consulting, waste management, financial services, compliance and transportation among others. Larger companies utilize business services to streamline and focus their own operations, especially during times of rapid growth. As such, support service companies can face competition from their own clients when services are insourced to trim costs or avoid layoffs.
The business services sector presents opportunities for private equity investment, since many service categories have a low barrier to entry and business models that lend themselves to fast growth without significant infrastructure investment. Additional traits associated with business services that align well with PE acquisition and investment include:
● Efficiency gains and scalability made possible through technology and automation
● Stronger resilience to economic downturns than many other sectors
● No development, handling, or shipment of physical products
The business services sector includes a mixed bag of companies offering the same or similar services at regional, national, and (in some cases) international levels. For this reason, growth in this sector tends to be acquisition based, focused on increased revenue and market share, which leaves companies leveraged and creates opportunities for streamlining and improving efficiency that can be supported by PE investment.
PE business services success stories
The scalability and resilience of many business services companies has not gone unnoticed by PE firms. This synergy continues to produce success stories that demonstrate how private equity investment can become a catalyst for ongoing growth and innovation.
National Financial Partners Corp
National Financial Partners (NFP), a provider of insurance and financial services, was acquired in a take-private transaction in 2013 valued at $1.3 billion by Madison Dearborn Partners. The business services company continued to expand through organic growth and acquisitions, including the 2023 acquisition of Actuarial Consulting Group. Madison Dearborn Partners then sold NFP to insurance giant AON in a transaction valued at $13.4 billion. With more than 7,700 emplyees and $2.2 billion in revenue at time of sale, NFP is a poster child for growth in the business services industry.
Drug Free Sport
Drug testing service provider Drug Free Sport supplies amateur and professional athletic organizations, including the NBA, NFL, and NCAA, with customized drug testing and compliance services. The company founder and CEO chose Valesco as a private equity partner to support their international expansion plans while gaining access to capital and a deep pool of operational talent.
Drug Free Sport has leveraged the opportunities provided by their PE partnership to expand into healthcare services and medical screening. A merger with anti-doping services provider IDTM allowed Drug Free Sport to achieve their goal of global expansion while delivering a more comprehensive selection of drug testing services.
In conclusion
Private equity investments have the potential to transform businesses in many ways, combining multiple forms of capital to revamp the culture, operations, and bottom line of the business simultaneously. It should come as no surprise that the business services sector has become an attractive target for PE investment. Scalable businesses like NFP and Drug Free Sport provide much-needed services that almost sell themselves, growing and expanding their scope organically to fill voids in the business world. Private equity can be the spark that sends these businesses to the next level of success.