Understanding Consumer Private Equity

Private equity investment firms are responsible for many of the highest-profile acquisitions in the consumer products sector. In this article we will discuss who these firms are, their motivations, deal structures and what founders can expect when selling to a private equity firm.

Hahnbeck’s focus is helping founders to sell their businesses, so this analysis will focus on private equity buyouts and majority investments, rather than minority investments, growth or venture capital.

LVMH-backed L Catterton is one of the most prominent private equity investors into the consumer products sector

Private Equity in the Consumer Products Sector

The CPG industry is one of the largest in the economy, representing 10% of GDP in the United States, for example. It is also dynamic, with new players rising to challenge incumbents all the time. It is therefore no surprise that the CPG sector is an important focus for private equity firms. These firms can be categorised into:

  • Generalist or broad private equity firms that have a division (or a fund) focused on consumer

  • Consumer-focused private equity firms, including:

    • Private equity firms focused on one particular category of consumer products (eg: beauty or “outdoors")

There are a number of private equity firm structures:

  • Traditional private equity, often categorised by size (small, large and mega cap)

  • Independent sponsors

  • Family offices

  • Smaller vehicles like search funds

  • Growth equity and venture capital

It is also important to consider those who invest into these private equity vehicles: the limited partners (LPs). Their priorities can have an enormous impact on how much capital is raised for investments into consumer products, which flows through to the priorities and the acquisitiveness of the firms who are investing in this sector.

Another way to look at private equity in the consumer sector is to analyse which firms are actively investing into which CPG categories. For example, Hahnbeck has recently looked at:

We will be analysing the entire consumer products sector, one category at a time.

Private Equity Acquisition Targets

Not every business is a target for acquisition by a private equity buyer. A number of factors determine whether a business is likely to be a target for private equity.

Size

The target company must be large enough to be a worthwhile acquisition for the private equity firm. Size is relative to the assets under management (AUM) of the firm, the size of the particular fund they are investing out of, and whether they are considering the target company as:

  • a potential platform asset

  • a potential add-on asset

A platform company is the foundational asset in an acquisition strategy - it would be a beachhead for the PE firm in a particular category, from which they intend to grow. Add-on companies that are complementary to the platform company are acquired and integrated with the platform company. For this reason, platform assets are typically much larger than add-ons.

Few private equity vehicles (other than very small firms like small search funds) will consider acquiring a business with less than $1m EBITDA. At $2m EBITDA a business becomes attractive as an add-on to a larger number of private equity firms. The minimum criteria for aplatform asset varies from $5m EBITDA (occasionally lower) to above $10m EBITDA.

Growth Rate

Like the majority of acquirers of all types, private equity investors strongly prefer growth momentum. Negative growth is not attractive. In cases where there are other strong reasons to make the acquisition, acquirers will sometimes overlook stagnant growth but it will impact the valuation.

Profitability

In the CPG sector strong margins are increasingly important for investors. While fast-growth, pre-profit DTC brands were funded (and acquired) by private equity in the past, sentiment today is strongly in favour of brands with strong and sustainable profit margins. There is little appetite amongst investors to take a gamble on a loss-making or marginal business in the hope that it can be made profitable during the period of ownership, unless the acquisition is being made in the context of distress, at a low valuation. There are exceptions to this rule, where an asset is highly valued for a different reason, or where it is clear that the cost structure of the business will change dramatically once it is integrated into a new parent company, but even in these scenarios, the valuations would be higher if they were not constrained by low margins.

PE firm Carlyle acquired a 50% stake in streetwear brand Supreme in 2017 at a reported $1Bn valuation before selling the business to apparel holdco VF for $2.1Bn three years later

Strategic Fit

The strategy of the acquiring firm is the most important factor of all. If an acquirer is conducting a roll-up of businesses within a particular category they may be primarily focused on scale and slightly less discerning about some qualitative elements of the business. An acquirer that sees a particular target as a key piece to a “puzzle” (for specific IP, access to a specific audience etc), will bid more strongly than one who sees the same business as merely one of many potential add-ons for their platform asset. An acquirer with a great deal of confidence in their ability to grow a particular business post-acquisition (through experience, a tried and tested “playbook” in that sector, etc) will be more aggressive in their approach than a PE firm for whom the plan feels more theoretical. The sector or category itself is vitally important also: in a sector that is widely viewed as highly attractive, almost all businesses that meet basic thresholds will be viewed as attractive acquisition targets.

Asmodee, owner of board games such as Dobble, was acquired by private equity firm PAI Partners in 2018. The firm grew Asmodee to a value of EUR 3.4Bn before selling it to strategic buyer Embracer in 2022.

Red Flags

To be attractive to a private equity buyer (or a strategic buyer for that matter), a business must not only be attractive, it must not have any major red flags that would present unacceptable risk to the acquiring firm. Red flags in areas such as compliance, intellectual property, safety, efficacy and others can cause an acquiring firm not to proceed with an acquisition, even if all of the other metrics (growth, margins, strategic fit) are highly attractive. It is important for business owners to address any such risks before going to market.

How To Sell To Private Equity

Selling your business to a private equity firm isn’t as simple as it sounds. Assuming your business is a suitable acquisition target for private equity (see above) there are a number of key considerations in finding the right private equity buyer and successfully closing the deal.

Private Equity Deal Structures

Since we are excluding minority investments, growth and venture capital from this article, the two main private equity approaches are:

  • Majority investments

  • Buyouts (100% acquisitions)

Selling 100% of the business is the default option for many sellers. Deals can be structured in many different ways, with some portion of the deal (typically 20-30%) deferred, although 100% cash offers are not uncommon in private equity. It is rare that private equity buyers would use seller’s notes to fund acquisitions and it is also rare that equity in the acquirer would be offered as part of the consideration. Full buyouts are more common for add-ons than for platform assets.

Majority investments are more common than buyouts for private equity firms. In these deals, the owners of the business sell a controlling stake (typically around 70% ownership) to the private equity fund and retain the remainder of the equity. The founders stay with the business, continuing to grow it with the support of the private equity firm, until the time is right to sell the business again - typically 5-7 years later. This type of deal can be extremely attractive to founders who can see enormous future potential in their business but need support to grow it further. Private equity firms can enable growth in a number of ways, from bringing in professional management to helping with international expansion, real estate, technology and partnerships with other businesses. There have been numerous cases of companies growing to many times their previous size under PE ownership, providing the founders with an even larger windfall on the second (minority) exit than the first (majority) sale.

It is important that founders understand these options and their implications when opening discussions with potential private equity acquirers.

Approaching Private Equity

Most founders dream of being “swept off their feet” by a firm that approaches them, snapping up the business for a high valuation in a quick process without missing a beat.

In reality, acquirers need to be identified and approached.

Founders cannot rely on their business being “discovered” by the acquirers for whom their business is the best fit and who are motivated to pay the most - in fact, those acquirers who do approach businesses directly are typically aiming to acquire at below-market valuations.

To reliably sell to a private equity acquirer, for a strong price and terms, founders must:

  1. Identify the private equity firms with the best strategic fit, for whom the transaction is the right size

  2. Negotiate the deal with them

It is critical to have a specialist M&A advisory firm like Hahnbeck on side in order to do both of these things effectively. As experts in the consumer products sector, Hahnbeck has a deep network of private equity firms all over the world, with an understanding of their existing portfolios and their acquisition priorities. Hahnbeck can identify the firms for whom the acquisition would be the best fit, in a far more effective way than the founder could hope to do on their own. In many cases, founders have never even heard of the majority of private equity firms we introduce them to.

Negotiating the deal is a multi-faceted process that begins before the acquirer is even approached. Optimising the business itself, then the business case, while approaching the right buyers simultaneously creates the circumstances in which an optimal valuation can be achieved. Managing the process and all interactions with the buyer, then formally negotiating the terms of the deal, are skills where experience and market knowledge is highly valuable. All of this is part of the negotiation process that optimises the result for the seller.