Private equity: is it for you?

and the future: keep it simple Private equity, your company and you'll keep it sweet

There are benefits to business owners of working with private equity investors for partial exits. JEREMY FURNISS explains.

IN OR out? It’s not always such a simple question. Entrepreneurs are increasingly selling stakes in their businesses to private equity (PE) investors.

These partial exits can be used to take some cash off the table, secure additional funds to reinvest into the company fund acquisitions or buy-out a partner. Whatever the reason, private equity has a role and, for many, it’s a compelling source of external funding.

To make a minority investment from PE work, entrepreneurs should consider the deal from the point of view from a PE investor, however, as well as their own. They’ll have to put in the prep and know what they’re doing to get the best deal…

First, they need to be clear what they want to achieve.

The reasons for entrepreneurs to bring in an external investor vary, but can be divided into two main areas: to provide capital to accelerate growth, or to diversify assets, create liquidity or personally “de-risk”.

PE investment provides benefits in both cases. In the first instance, a mature but still growing company may need more cash than it can generate from operations alone.

IMPROVING REVENUES PE can offer financing arrangements that will contribute capital — as well as (potentially) support and counsel on improving revenues or implementing programmes that yield operational efficiencies. Most PE firms bring not only investors with money, but also experience.

PE may help address a major issue for many entrepreneurs: that they have a considerable amount — often the majority — of their personal wealth tied up in the business. That might be necessary at the outset, but it represents risk in the long term.

Recapitalisation should create liquidity and allow business owners to extract cash to secure their financial situation and/or to reinvest in the business.

Despite the potential benefits, some entrepreneurs have a dim view of PE. It is inadvisable to generalise — and advisable to understand the PE perspective.

When PE investors get involved they are primarily concerned about their financial returns. If they take a minority stake, and become a relatively passive investor, they have an interest in the business’s success. Success will be defined by the business plan that the management team has developed. The plan defines expectations and creates a framework for management to take care of dayto-day business.

PE investors will insist on having a say on key strategic decisions, as well as certain preagreed operational issues such as CEO compensation. And they will want to be informed early if things start to go wrong.

If things do go wrong, and management does not appear to able to cope, a minority PE may want to step in. In extreme cases, this may include the power to fire the CEO, or take over management of the business.

This is the worst possible outcome for any PE, which needs to protect the investment.

PE firms are likely to insist on formal governance structures.

This could be part of the incremental value PE brings to a company.

It is important to work with trusted and experienced advisers during the sale process to ensure proper understanding. Expert advisers will know which of the PE’s requirements are reasonable.

Be clear about

objectives and

align interests

Finding the right advisers is vital when bringing PE investment on board. Business owners should be careful to choose an adviser who understands the industry, as well as the process of PE investment.

Advisers should be able to guide their client to investors and create a competitive process to improve the company’s value. Good PE investors should be comfortable with firms taking advice, and if not it is worth asking why.

Choosing the right financial partner is the most important driver of successful investment. Most investors have an established reputation, sector emphasis and style of transacting; entrepreneurs need to do their due diligence.

That means looking not just at the firm’s reputation, but also at the individuals involved. Who is involved in the final decisionmaking process? Who sits on the Investment Committee, and is that committee excited about your company and deal?

These are the people the business owner will be working with, and it’s important to develop a level of trust.

Being clear about objectives is crucial to ensure that interests are aligned. PE investors and business owners should be clear about their responsibilities post-sale.

The groundwork for a successful partial exit deal should begin before the search for an investor. That means having robust accounting and finance systems, a tidy balance sheet, and, where possible, at least a year of growth and an order book that shows that the company can sustain its momentum. The key component for a partial sale will always be the leadership figures.

* Jeremy Furniss is a partner at Arrowpoint Advisory