With access to capital critical for the expansion and growth of one’s business, there comes a point where entrepreneurs need to consider attracting new forms of investment based on the significant cash injection required.
Options considered usually include listing or, alternately, taking on a private equity (PE) partner. With both able to achieve the same objectives, it’s important that entrepreneurs consider the respective implications before choosing which option will best ensure the sustainable success of their business.
The options available
Capital and liquidity are essential for the growth of one’s business. At some stage, however, many entrepreneurs will require a much larger capital injection than the bank will loan them to take their business to the next level. This is when listing or taking on a PE partner become viable alternatives.
While both options will allow an entrepreneur to raise capital fairly rapidly and increase liquidity, they will also assist the business to improve its profile in the market – thereby achieving the same strategic objectives.
Listing and PE have very different implications for a company that entrepreneurs need to be cognisant of from the outset.
In both scenarios, one is inviting external parties to become involved in the core functioning of the business. Because of this, it’s important to appreciate how these new relationships will work, and the obligations and roles of each.
Listing your company
Listing your business in a positive economic climate can work particularly well, as prices and earnings increase on the back of investor confidence. This is what we saw in many of the local listings that took place in the market about five years ago.
The recent global economic downturn has changed this significantly though, reducing the amount of liquidity available and making investors more reticent to invest in newer ‘unknown’ companies. When liquidity is at a premium (as it currently is), big fund managers typically pursue blue chip investments in favour of small-cap companies.
As a result, small-cap companies are punished in this type of cycle – going against their original intention for having listed. Because trading is slower and somewhat restricted, a business’s shares can become inert, with prospects for raising capital and increasing liquidity significantly limited.
Companies also often list in order to make future acquisitions. In recent years, the option of using a listing in order to purchase another company has, however, been curtailed as operators are reluctant to sell for ‘paper’ – rather wanting cash for the sale.
There are a number of other considerations to take into account before listing. When listing, one is moving from the context of a private company to that of the stock market where dealings are highly regulated and scrutinised. This has various consequences for one’s business.
From a corporate governance and administration perspective, there are a number of very stringent requirements to adhere to. One must consequently have the right systems in place in order to meet these on an ongoing basis. The level of reporting required by a listed company also makes it fairly easy for one’s competitors to analyse one’s business; establishing everything from margins to positioning of one’s competitive advantage.
Before making any decisions, understand what you are getting yourself and your business into. Should listing not prove the right option for a business in the long term, delisting can be costly and have negative implications for the company’s profile. To this end, listing should be based on a sound forecast of increased earnings projected over the next five years, in a bullish economic climate.
There are pros and cons to listing as well as taking on a private equity partner. The important consideration is what suits your business. Many entrepreneurs don’t realise that a PE partner offers concrete liquidity and is usually open to new acquisitions – offering a viable alternative to listing purely for this reason.
Because PE players also assist with management buyouts, they can bring new blood and expertise on board during the process, enriching the talent pool and potential of the business. PE goal-posts are different to those of a listing, and PE partners are typically in it for the long haul: what happens in the interim is not as important as overall performance of the company.
As such, one’s PE partner is normally far less interested in a linear trajectory of earnings than the market would be. This is because they’re ultimately working towards selling at the ‘right’ time, even if the business takes longer to reach that point.
By joining the board of the business, a PE investor can also provide invaluable expertise and act as a source of independent advice to management. In the case of RMB Corvest for example, our objective is to understand the business and add value.
This means that, while we don’t become actively involved in managing the company, we attend board and management meetings. In this way, involving a PE partner can bring the right combination of liquidity and expertise to a business, especially if it’s a small-cap company. It can also act as a step on the path towards listing – improving corporate governance procedures and boosting growth prior to entering the market.
Thus while listing and involving a PE partner both offer entrepreneurs a means of taking their businesses to the next level, the most important part of the process is arguably making the right choice between them.
The starting point is to research — and understand — the options in the context of your own business. Remember that this is the next step in positioning your company for sustained success and growth. As such, your strategic objectives must be aligned with the means of achieving these.