Over 35 companies are rapidly changing the face of the veterinary services industry, and most of them are financed by private equity (PE) firms. If you’re thinking about selling your practice, it’s key to know who’s really pulling the strings. Most of these consolidators are backed by PE firms, with a few supported by family offices. Private equity is a big part of today’s market, known for its highly analytical approach to improving business performance and aiming for strong financial returns. So, who are these PE firms, and how do they operate? We’ve put together a no-nonsense guide to private equity to clear things up. Read on to dive deeper into the world of PE.
The Evolution of Private Equity
Historical Background and Rebranding
“Private Equity” rose to public prominence in the 2012 presidential election with the publicizing of Mitt Romney’s leadership at Bain Capital, a major PE firm. However, the PE market started in the 1980s and has become an ever-increasing part of the U.S. economy through the 1990s, 2000s and 2010s. Private Equity is the “rebranded” name for what were originally known as Leverage Buyout (LBO) firms in the 1980s. LBOs essentially bought companies using significant amounts of debt. You may recall some of these PE firms and their takeovers before–for example, KKR buying out RJR Nabisco, Blackstone purchasing Hilton, and Apollo and TPG Capital acquiring Harrah’s.
The Growth of PE and Its Strategies
In the 1980s and 1990s, the PE industry was known for “financial engineering.” Simply put, they bought businesses using lots of debt, made the operations incrementally more efficient, eliminating ‘bloat’, and sold the businesses or took them public three to seven years later. Financial engineering worked for the first 10 to 15 years, but as more and more firms entered the business, strategies needed to evolve as the PE industry became more competitive.
By the early 2000s, the industry rebranded from LBO firms to private equity, implying a shift from pure financial strategies to an attempt to help grow and build businesses. Over the past twenty-some years, the PE world has grown exponentially–there are now thousands of firms pursuing different investment strategies and even more PE-backed companies in the U.S.
Today, PE is an enormous part of the national and international economy. The amount of money (or capital) invested in these firms is astounding: They control trillions of dollars in their investment funds and have over $1.45 trillion of ‘dry powder’, or money to invest.
Distinctions Between Private Equity and Venture Capital
Investment Focus
Venture Capital (VC) and Private Equity (PE) exhibit distinct differences in their investment targets and associated risks. VC firms typically invest in startups and early-stage companies, usually before these businesses have started generating profits and sometimes even pre-revenue. These investments are high-risk; VC firms expect a high failure rate, with the potential for extraordinary returns from a few successful ventures.
On the other hand, PE firms focus on more established businesses that typically generate substantial revenues and profits, typically at least $3 million in profit. These companies offer a lower risk profile than VC firms, as they have proven business models and consistent revenue streams.
Operational Models and Expectations
The operational strategies and expected outcomes for VC and PE also vary significantly. VC firms operate under a model that anticipates and accepts failure: a typical VC fund invests in 10 to 15 companies, expecting that at least half to fail. However, they also predict that a few will achieve exceptional success, potentially returning 50 to 100 times the original investment. Successful examples include early investments in tech giants like Google, Facebook, and Uber. Conversely, infamous failures like Theranos and Pets.com showcase the high stakes and public nature of VC missteps.
In contrast, PE firms aim for consistent and strong returns by investing in businesses with proven profitability, which allows them to use debt (otherwise known as “leverage”) to finance acquisitions. The lower cost debt boosts the return on the equity capital invested by the PE firms. The focus here is on mitigating risks rather than high-risk, high-reward gambles. PE firms generally see very few complete failures, as their investments are already established companies. A successful PE investment would yield returns up to 2.5 times the initial outlay, with a much lower variability in returns compared to VC investments.
Who Funds Private Equity?
Major Investors
Private equity (PE) and venture capital (VC) funds attract significant investments from a variety of large institutions and wealthy individuals, all looking to diversify beyond traditional stock and bond investments. PE and VC funds are categorized under alternative investments, which also include hedge funds, real estate funds, and other investment vehicles. Here’s a breakdown of the major types of investors:
- Endowments: Many colleges, universities, and non-profit organizations invest a portion of their sizable endowments into PE and VC to secure long-term financial returns that are less correlated to the stock market.
- Public Pension Funds: Entities such as teachers’ pension funds and state employee pension funds invest in PE and VC to meet their financial obligations to retirees.
- Insurance Companies: These companies manage large reserves of capital, part of which is allocated to longer-term, illiquid assets like PE and VC to balance potential future liabilities.
- Sovereign Wealth Funds: Nations with substantial financial resources, such as oil-rich countries like Saudi Arabia and Dubai, frequently invest in PE and VC to enhance their wealth portfolios.
- Wealthy Individuals: High net-worth individuals also contribute to PE and VC funds, seeking to maximize their investment returns through these alternative avenues.
Role of Limited Partners (LPs)
Investors in PE funds are commonly known as Limited Partners (LPs). LPs have minimal involvement in the day-to-day management of the funds but play a role in the vetting the investment firm and their strategy. LPs conduct due diligence on the PE firm’s leadership team and entrust them with the authority to make investment decisions. While the PE firm actively manages the fund, LPs provide the capital and have limited decision-making powers, focusing instead on oversight and performance evaluation. This structure allows LPs to benefit from the expertise of PE managers while mitigating the risks associated with direct management of the investments.
Quick Aside: What is a ‘Family Office’?
A “Family Office” is distinct from private equity (PE) and venture capital (VC) firms in that it manages the wealth of one or a small group of wealthy families, without raising capital from external investors like limited partners (LPs). Family offices are known for their long-term investment approach, often holding investments for 10 years or more, unlike PE funds which typically exit within 3 to 7 years. This flexibility allows family offices to pursue higher long-term gains without the external pressures and constraints faced by PE firms.
Types of PE Firms & Their Strategies
Market Segmentation
Private equity (PE) firms vary significantly in size and focus, impacting how they allocate capital and choose investments. These firms are typically categorized based on the amount of capital they manage and the scale of their investments:
- Lower Middle Market Firms: These firms invest in businesses generating $2 to $10 million in EBITDA, with typical equity investments ranging from $10 to $50 million. They often use a moderate level of debt to finance these investments.
- Middle Market Firms: These target businesses with $20 to $75 million in profits, making larger equity investments of $50 to $300 million and commonly leveraging debt to finance deals.
- Large Firms: The largest PE firms, like KKR, Blackstone, and Carlyle, manage funds capable of substantial investments. They focus on businesses with $75 million to $500 million in profits and can write equity checks ranging from $300 million to $2 billion, often relying heavily on debt financing.
Diverse Investment Strategies
PE firms adopt various investment strategies based on their market segmentation and targeted returns:
- Growth Equity: Focused on high-growth companies, these firms invest heavily in sectors like veterinary services, healthcare, and technology. Unlike traditional buyouts, growth equity investments involve less debt and higher equity investments to fuel growth initiatives.
- Distressed Funds: These funds specialize in turning around large businesses in financial distress. They believe in their capacity to restore profitability through operational improvements.
- Traditional PE Funds: These firms typically pursue slower-growing businesses, acquiring them at lower multiples. Their strategy is to enhance profit margins and accelerate revenue growth to secure stable returns.
PE firms often specialize in specific industries, developing deep expertise that aids in making informed investment decisions. For instance, some PE firms focus exclusively on sectors like healthcare services or consumer-facing healthcare, allowing them to capitalize on industry trends and dynamics. Notably, some traditional PE firms have also ventured into backing “startup” veterinary consolidators, recognizing the stability and growth potential in this niche market. Examples include AmeriVet by Imperial Capital and Companion Pet Partners by Cortec, both of which have successfully launched veterinary services from scratch.
How Do PE Firms Work?
Business Model and Revenue Generation
Private equity (PE) firms operate on a business model that primarily generates revenue through management fees and carried interest. Management fees typically amount to about two percent of the total fund; for example, a $500 million fund would accrue $10 million annually in management fees. Additionally, PE firms collect carried interest, generally about 20 percent of the profits, which may be subject to hurdle rates that require a minimum return to investors before the carried interest accrues. This structure ensures that PE firms are financially motivated to increase the value of the companies they invest in.
Governance and Management
PE firms typically hold a majority stake in the companies they invest in, with the remaining ownership held by company management. The governance structure usually includes a board of directors comprising two to three representatives from the PE firm, an independent board member with relevant industry experience, the CEO, and potentially another senior executive from the company. This board meets quarterly to set strategic directions and approve major decisions, providing significant oversight while leaving day-to-day management to the company’s executive team. This model is prevalent among veterinary consolidators, where the board also oversees proposals to acquire individual practices.
The Role of PE in Veterinary Industry Consolidation
Impact on Veterinary Practices
PE firms play a significant role in the consolidation of veterinary practices, primarily by instilling a strategic framework and providing capital for acquisitions and operational improvements. By acquiring and managing multiple practices, PE firms can drive efficiencies and scale operations, which often leads to enhanced service offerings and improved patient care within the consolidated entities. Additionally, PE-backed consolidators typically focus on key performance metrics and growth objectives, aligning management goals with broader business strategies.
Considerations for Selling to a Consolidator
For veterinary practice owners considering selling to a PE-backed consolidator, understanding the operational and financial implications is crucial. Selling to a PE firm can offer financial security and resources for growth but may also come with changes in how the practice is managed. Owners should evaluate the consolidator’s track record, investment philosophy, and the potential impact on their practice’s operations and culture. Additionally, understanding the typical exit strategy of the PE firm—usually aiming to sell the consolidated entities within three to seven years at a significant return—can provide insights into the firm’s long-term commitment and strategic goals for the practice.
If you’re thinking about selling your practice to a consolidator, it’s important to know a bit about who’s behind them. Most veterinary consolidators are owned by private equity (PE) firms, and a few are backed by family offices. Private equity is a big player in today’s economy, and these firms are known for bringing a disciplined, analytical approach to the businesses they invest in, aiming for returns that beat the market. These companies and firms are extremely skilled and have a wealth of resources at their disposal. When you decide to sell your practice, facing them alone isn’t your best option. Consider talking to an experienced broker like Ackerman Group, who can help you secure the best terms and deal possible.