Mad Money with Jim Cramer is one of CNBC's biggest hits. Every Thursday viewers call in to play "Am I Diversified?" they give Jim their 5 top stock holdings and he tells them based on business segment and speculative verses big cap, whether their portfolio is diversified or not. Many Private Business owners may not realize they would lose this game miserably. We have found most private business owners have over 80% of their net worth tied up in their business and its assets. This means at least four of their five largest positions are tied up in one holding, their own companies stock.

Conventional wisdom would say it is reasonable and necessary to have most of your assets in your own business. Long term conventional wisdom made it acceptable for GM and AIG employees to have most of their investments (and retirement) tied up in their employer’s stock, Who knows the company better then its employee? This failed idea goes back much further; remember Enron, MCI WorldCom, TWA and Eastern Airlines?  All of these were “Wall Street Darlings” at one point, and they all went under.

A business owner may say what choice do I have? I built this business through my own blood, sweat and tears.  Furthermore, I am not close to retirement and I simply do not have a choice. You do have choice. You can extract some or all of the equity from your company, diversify your hard equity in various investment vehicles and continue to run your company until you are ready to move on and/or retire. We help people do this on a regular basis. Just as many of our customers are “40 somethings” as “60 somethings.” This is made possible by Private Equity Groups (PEGs) {see a prior blog at} http://blog.mandaadvice.com/2009/04/23/2009-is-a-horrible-time-o-sell-my-businessyou-could-be-very-wrong.aspx on the excess of cash and shortage of deals.

Of the PEGs we deal with on a regular basis, I would estimate about 30% are truly "Operations Oriented" and ready to take over the day to day activities of a middle market business. The majority of PEGs are looking to buy the cash flow of a business and have a successful owner-operator (OO) continue to run the business for an extended period of time. If a PEG is happy with an owner-operators performance, they will often buy add-on companies for that operator to oversee.

We had a recent OO client sell his business to a PEG.  They were primarily looking for cash flow and paid him four times EBITDA for his simple, but well run contract manufacturing business. They pay the OO more salary than he ever paid himself, plus 75% of the deal was in cash at closing and they pay the OO an eight percent (8%) note for the remaining balance on a quarterly basis.  Finally, the PEG set bench marks for sales and cash flow which yielded the OO bonuses since he sold the business. The PEG is now in negotiations to buy another similar business, roll it together with the first, and up the salary/bonus structure of the OO to run this second business even though the first business has suffered in the recession. This PEG has a long term view and understands a good OO is as valuable as a profitable business. This OO has diversified several million dollars in stock, fixed income, real estate and even several private equity investments. He is now in a position to win "Am I Diversified?" and continues to profit handsomely from the business he has built.

The PEG will eventually grow and sell this investment 7-10 years down the road, but only when they are convinced they can get more cash flow and growth elsewhere. This exit is usually not the end of the relationship between the OO and the PEG. We consistently get call from PEGs asking for any company generating $10-$20 million in sales in a certain geographic area to place a successful OO from an investment they have recently exited. This story is not out of the ordinary for successful OO's, it is common for PEGs to place a successful OO at another investment while they try find something near the OO's preferred location. Some PEGs prefer or require an OO keep a minority stake in the company so they "have some skin in the game." Some PEGs even allow the OO to earn back equity in the company based on performance. These later two scenarios allow the OO to "double dip" on his sale to the PEG and again on his equity stake when the PEG exits.

There are too many other variations on PEGs and Strategic Acquirer deals to describe in this forum.  The underlying theme is PEGs buy companies because they like the business and the way it is run by the owner. The PEG will try to maximize their investment in both the business and the OO which leads to a win-win scenario. Are you ready to diversify?