What does “private equity” mean to you? It is a term that has become almost mainstream, but that doesn’t necessarily mean that we all understand what it actually is, and what it can offer growing owner managed businesses or SMEs.
Before we start, maybe we should explain what private equity or “PE” is. Private equity is the general term for investment firms who raise money from pension funds, wealthy individuals, sovereign or family funds, to specifically invest in growing businesses. The funds vary in size, scope and sector, and historically were mainly focused on large mega-deals. Over time this has changed and there are now more firms than ever targeting small and medium sized businesses.
As a result, private equity has become a mainstream funding option with many mid-market firms having raised new funds in the last 18 months now actively seeking new business opportunities. More of these funds than ever are finding their way to supporting transactions in the SME sector.
Very broadly the types of deals private equity will support can be split into three types:
1. Development capital:
100% of the investment remains in the business providing funds for a business to, for example, invest in R&D, develop a new site , expand overseas , or undertake an acquisition. Often these types of transactions are funded by types of firms called Venture Capital Trusts or “VCTs”.
2. Partial exit or shareholder restructure:
This scenario could occur where some of the shareholders want to sell all or part of their stake. It often forms part of an exit plan for a shareholder in the business who might be looking to take a step back from the running of the business and sell some of their shares. Partial exit is a great method for shareholders and founders who are not yet ready to sell all of their business, but may like to take some cash out of it.
3. Management buyout (“MBO”):
In this case the owner is typically seeking to sell most or all of their business, with the management team remaining to take the business forward. PE can provide funds to support the existing management team to acquire the business. This is a good alternative to a trade sale where there is a strong management team in place who would like to retain the independence, and participate in the future as shareholders.
In either an MBO or a partial exit, the PE funds can provide additional capital for development, supporting the new management to make step changes in the business which may not have been possible under a previous owner.
So why would you consider a private equity partner for your business? Let’s consider some of the benefits:
- They are an excellent business partner: Obviously they can provide financial support to the business as it grows, but they offer more than just cash, they can provide advice on issues ranging from recruitment to business development to overseas expansion or integrating acquisitions.
- They offer flexible deal structures: Most PE firms are flexible with regard to deal structure, taking a majority or minority shareholding as appropriate. This allows them to offer a solution to a particular shareholder problem or challenges that may seem at first glance intractable.
- They offer the management team the ability to participate in future success: Most of the PE houses have a very strong ethos of “backing” a management team. They want the team to succeed, so that the PE house succeeds, and part of that is enabling management to participate in the business as shareholders.
- They make it easier to raise bank debt: Banks are comforted by the presence of a PE investor and it can often make it easier to secure bank lending and services. Don’t be scared off by the stories of PE houses loading a business with debt; the mid-market firms do not operate in that way, and will look to add a manageable amount of leverage to any deal.
- Take the lead on exit strategy: A PE firm is not an investor forever, and they will look to sell the business on after perhaps 4 or 5 years. However, they will take the lead during this process, and will invest time and resources to work with the business on an exit strategy securing the best return possible for all shareholders, including management.
It goes without saying that it is important to have the right advisory team with you during a private equity deal, who have been there before and can guide you through the process. A good corporate finance advisor will help you present your business in the best way, as well as introducing you to the private equity houses that will best suit your requirements. Good legal advisors will help you navigate the various documents, which can be a little daunting at first, as well as negotiating on your behalf with the PE firm’s legal advisors.
I hope this article has made you think about private equity in a different, hopefully more positive way. Private equity might not be right for everyone, but you won’t know that unless you consider it.