The Private Equity Auction: Balancing Benefits and Risks — and the Importance of Assessing Leadership and Culture

In the world of private equity, an auction process is a common way to acquire deals and make investments. This process involves attracting multiple bidders who compete for the same company or asset, so the seller can receive the best possible value for their asset. The fast-paced auctions differ from the traditional business development and corporate development process in many ways. Among the differences is the limited opportunity to learn about and develop relationships with the founders, executives and management teams of target acquisitions in the auction process. This is often a concern for many of our private equity and strategic buyers. Most parties acknowledge and seek to take advantage of the benefits to an auction, while at the same time reducing its inherent risks.

Let’s first explore the auction process and its benefits.  

The private equity auction process 

• The auction process begins with the seller providing an overview of their investment opportunity, usually in a request for proposal (RFP).
• The seller sends out this RFP to interested parties, which may include both strategic and financial buyers. Sellers will usually provide information on pricing criteria and other key deal terms.
• Buyers respond back with their offers – typically as either a multiple of cash flow or an estimated enterprise value.  
• The seller may set up a competitive bidding round between selected bidders or simply select one bidder straight away, depending on the number of responses received.
• Negotiations occur without public awareness of what is being discussed. As each offer progresses through the rounds, there will be offers from both a strategic buyer (e.g., another business in the same industry) and financial buyers (private equity groups) vying for control of the asset at different points in time.  Often times these offers won't perfectly align but all parties must reach an agreement to move forward.
• Offer is accepted
• Due diligence continues to move forward towards closing.
• Deal is closed.

At its core, a private equity auction ensures all interested parties are given equal voting rights, which increases competition among potential buyers and ensures fairness in pricing and protects the seller’s interests in achieving the maximum amount they can get from the sale of their asset or stake in whichever company they have put up for sale.  

Benefits of a private equity auction 

Private equity firms conduct auctions for several reasons, including: 

• Competitive bidding: Creating a competitive bidding environment can help drive up the price of the company and result in a higher sales price for a sell and higher return on investment for the private equity firm (if they are exiting an investment through this process). 
• Speed and efficiency: Provides a fast and efficient way to acquire a company. The private equity firm can quickly identify the most attractive acquisition targets and move quickly to secure the deal. 
• Access to a wider pool of potential targets: Gain access to a wider pool of potential acquisition targets, as companies that may not have considered a private equity investment may be more willing to participate in an auction. 
• Improved due diligence: Multiple bidders will conduct their own due diligence and provide the private equity firm with a more thorough understanding of the company — and its potential risks and rewards. 
• Increased transparency: All bidders have access to the same information about the company and can make informed decisions about their bids.

Risks of a private equity auction 

Like many of these processes, the benefits must be weighed with the risks. A private equity auction process can be complex and competitive — and they tend to happen at a rapid pace and in different sequences than a typical business or corporate development process.

Here are a few of the risks: 

• Overpayment: In a competitive bidding environment, private equity firms may be tempted to overpay for a company, resulting in a lower return on investment and increased financial risk. 
• Due diligence failures: The due diligence process in a private equity auction can be rushed, and important information about the company may not be fully understood or disclosed, creating significant financial and operational risks. 
• Integration risks: Integrating an acquired company into a private equity firm's portfolio can be a complex and time-consuming process, and there is a risk that the integration may not be successful, leading to a loss of value. 
• Competition with strategic buyers: Private equity firms may face competition with strategic buyers, such as large corporations, in the auction process, which can drive up the price and increase the risk of overpayment. 
• Regulatory risks: Acquiring a company in a private equity auction process can involve a complex and time-consuming regulatory approval process, and there is a risk that the regulatory approval may not be obtained, which could result in the deal being cancelled or delayed. 
• Reputational risks: Participating in a private equity auction process can have reputational risks, particularly if the process is perceived as aggressive or unethical. 

Assessing leadership and culture in mergers and acquisitions auctions 

An often-cited statistic — 70-90% of all mergers and acquisitions fail to achieve their intended outcomes largely due to concerns related to leadership, people and culture, should be reason enough to look deeply at human capital in due diligence and post-acquisition integration.  However, in the fast-paced auction process where speed, competition and lack of access can impede a buyer or investor’s ability to evaluate these capabilities in concrete and meaningful ways, human capital assessments are more difficult to execute.

In proprietary deals, a firm might spend a year working with the leadership team and understanding a company’s strengths and opportunities. But, in an auction deal, there’s far less time to assess the team and far more unknowns around the work to be done post-investment, leaving a critical component of the auction process incomplete.

Assessing leadership and culture in a private equity auction process is critical to ensuring that the company is well-positioned for growth, has a strong and capable leadership team, and is a good values-fit with the private equity firm.

One of our clients shared this feedback after asking us to complete executive, leadership and culture assessments during their auction process,

 “We went into the deal with a set of assumptions around what was going to be needed. But after diligence, we completely shifted our roadmap, recognizing that the top three things we needed to address were related to people and culture.”   

According to Ocean Tomo (2020) approximately 90% of today’s S&P 500 market value is made up of intangible assets (including our people). Our economic reality has shifted, making leadership and people considerably more important to value creation than in decades past. Numerous studies have concluded that higher levels of employee engagement translate to positive economic outcomes for business enterprises. Leadership and management practices disproportionately influence employee engagement. So, it makes sense that assessing the leadership of a potential acquisition target is important in a private equity auction process for several reasons: 

• Leadership drives strategy: Responsible for setting the strategy of the company and executing it, a strong and capable leadership team can help drive growth, increase efficiency, and make the company more attractive to potential acquirers. 
• Talent retention: A change in ownership can often lead to changes in the leadership team and a potential loss of key personnel. Assessing the leadership team's ability to retain key employees and attract new talent is important to maintaining the company's value. 
• Cultural fit: The leadership team plays a critical role in shaping the company's culture and ensuring that it is aligned with the values and vision of the private equity firm. Assessing the leadership team's ability to integrate with the private equity firm's culture is important to a smooth transition and long-term success. 
• Financial performance: Assessing the leadership team’s track record and ability to deliver results is important in determining the potential return on investment for the private equity firm. 

The auction process is a common way for private equity firms to acquire deals and make investments. However, limited access to information about the target company's leadership and management teams can pose a challenge for both private equity and strategic buyers. 

Assessing leadership and culture in a private equity auction process is crucial for ensuring the company is well-positioned for growth, has a strong and capable leadership team, and is a good fit with the private equity firm's values and vision. The team plays a critical role in driving strategy, retaining talent, shaping company culture, and delivering financial performance — and in an environment where intangible assets, including people, are our source of greatest value and competitive advantage, assessing leadership is increasingly important in private equity auctions. 

Navigating these challenges may seem difficult.  Seek expertise advice and guidance, we’d be very happy to help.  Please drop us a note or give us a ring. And, please share this with others.