The Price of Money: Is private equity right for your business?
Looking for capital? Private equity could help your business grow, but it may not be your business anymore
by Alix Kemp
Whether you’re starting a new business, growing an established one or looking to exit entirely, private equity has something to offer.
But while private equity often looks attractive, it can come with a lot of strings – expensive ones, too. As such, it’s often a poor fit for many companies that would be better off looking for other sources of financing. So how do you know if private equity is right for you? And if it is, how do you get it?
What A Private Equity Firm Wants
Jeff Belford, a senior management director with Calgary’s TriWest Capital Partners, has been on both sides of the private equity equation. He used to be the CFO of Swiss Water, a company TriWest acquired in 2000, and joined TriWest in 2003 when it was starting its second investment fund. Like most investors, Belford says private equity firms are after returns, and that means they’re typically interested in companies with proven track records, but also the potential for future growth. “There has to be a clear path to some upside for us as an investor, and obviously if we’re bringing management in to invest beside us, they’ve got to believe there’s lots of upside, too.”
There are a few exceptions. Some private equity firms specialize in turning around distressed companies rather than acquiring businesses that are already doing well, and venture capital firms obviously look for companies with great potential rather than current revenues.
But believing in the potential of a company isn’t enough. To ensure that return, and in exchange for their money, private equity firms expect the companies they invest in to give them a degree of control. For a partnership to work, Belford says, company management and the private equity firm need to ensure their interests align, and “everyone is pulling in the same direction.”
The Exit Strategy
Private investors invest for between three to seven years and always have an exit strategy, which usually takes the form of an initial public offering or a sale to another company or private equity firm. But what if you don’t want to relinquish control of your company and aren’t interested in an IPO? In some cases, it’s possible for companies to repurchase the shares controlled by their private equity partner, although this is uncommon because investors may feel they’re not getting the best possible return on these deals, and because it can be difficult for companies to raise the necessary funds to do it in the first place.
The point is, in the vast majority of cases, using private equity to finance your business means relinquishing at least some control of your company, generally permanently. That means private equity is an ideal strategy if you’re looking to retire or take a step back from the day-to-day operations of your business. If you’re a control freak, you’ll be better off looking for other sources of capital.
Risk vs. Reward
Private equity investment isn’t without its risks. Private equity firms typically put some leverage – and sometimes quite a lot – into the companies they invest in, which could have consequences if there are any hiccups in the economy. “If you get into a situation where the company has leverage and some external factors really hurt the performance of the business, then for a period of time, that creates challenges for a company,” says Belford, and in some cases it can cause a company to fail. You can mitigate those risks somewhat by choosing a private equity partner that’s more cautious with the amount of leverage it typically employs.
Know Your Funds
Private equity can be roughly divided into three categories, depending on the age of the business and its goals. Most private equity firms specialize in just one kind of equity, although some venture capital and late-stage private equity firms also have funds devoted to growth equity.
Early Stage: Venture Capital
For that newly established (or not-quite-established) company, venture capital provides the money and expertise to get off the ground. Venture capital is especially popular in the technology sector, where startups are constantly seeking out private investment.
Mid Stage: Growth Equity
You’ve already got a proven, successful business, but you want to launch a new product, expand into new territories or acquire a competitor. You want growth equity, which focuses on later-stage companies that have solid revenues and a good track record, but need a push to the next level. Growth equity firms usually buy a minority stake in a company.
Late Stage: Buyouts
Want out? Late-stage private equity companies focus on purchasing mature companies that may not be growing quickly anymore. Investors focus on maximizing operational efficiencies and increasing company value before selling it at a profit.
An Attractive Offer
So, you’ve decided that private equity is the right fit for your business. How do you make your company attractive to potential investors?
- Be Expendable
Chances are, if you’re looking at private equity, you’re going to be stepping back from your company to at least some degree. That means before you approach a private equity firm, you need to be thinking about succession planning and building a company that can operate without you. “You see a lot of companies that are great businesses, and they’ve been created from very entrepreneurial owners, but they haven’t really thought about succession, and that’s a problem,” Belford says. “They need to go find a person they can put in place and groom well before they’re considering an exit or a partial exit.”
- Money Management
Belford suggests that engaging an accountant or a CFO to handle your business’s financial affairs could make all the difference when it comes to attracting a private equity firm. “When any firm is coming in to do due diligence and really understand what’s made a company successful, having that strong financial person is going to take a lot of the heat off the owner or the president.”
- Know the Future
While the day-to-day operation of your business may consume most of your time, it’s essential to take some time to think about the long-term plan for your business. If you know where you want to go, and what sort of help it will take to get there, you’ll be in a much better position to meet with potential investors. “Understanding what you need is a huge advantage,” Belford says.