Private equity partners have a vested interest in growing companies they buy into, in the years up to their exit. Their goal during this period is the same as yours: To increase the value of your company by expanding the business.
Entrepreneur spoke to Jeff Bunder, a private equity specialist, about the relationship between PE and entrepreneurs. He stresses that whether or not to take on private equity financing is a complex decision.
It requires profound analysis of your personal and business goals, the market environment, and the financing options available. Focusing on these important considerations and avoiding common misperceptions will help you, the business owner, make the right decision.
What are the benefits of a private equity deal for the entrepreneur?
Private equity can be a highly effective way of generating business growth – PE firms not only inject capital into growing businesses, but they also provide broad networks and experiences from working with and growing other similar businesses.
Experienced PE professionals will analyse and provide input to improve on business plans, operational strategies and financial modelling in order to meet set return or hurdle rates for the benefit of the business and their own investment.
They will also examine the industry in which your business operates to improve on competitive strategies and supplier relationships. Traditionally, PE firms have far longer investment horizons than traditional financial funders such as banks and therefore provide the business with time to execute their growth strategies.
How have private equity investors changed their thinking post the global economic crash?
Today, private equity firms have pivoted from cost-cutting and value-preservation to more of a growth agenda for the companies they back. This shift has set the stage for positioning companies well at the outset of the deal to achieve successful, higher value exits while also driving higher returns.
PE investors are able to capitalise on high growth markets and areas for product offerings, make fundamental operational improvements to companies, back the right management teams and effect sustainable value creation.
As the average holding period for portfolio companies exceeds five years, PE firms have expanded their skills to focus more on growth agendas to ultimately create sustainable value in these businesses.
PE firms have pivoted the way they work with companies. Cost-cutting and efficiency gains were imperative in the immediate aftermath of the financial crisis, but PE firms are increasingly focused on organic revenue growth as the key means of creating value.
PE firms are concentrating their efforts on investing in portfolio companies to support growth in new markets, product lines and business areas and through add-on acquisitions – cost-cutting is no longer an imperative.
PE firms continue to reinvent themselves in a challenging economy, using the time to regroup and redirect efforts. The key factors of success for PEs are still the same – buying well, executing well and selling well – but the processes and resources have been strengthened to ensure portfolio companies are in the best shape possible, positioned to capitalise on an improving economy and ultimately exit.
Meeting With Investors? Don’t Do This!
Why do so many entrepreneurs believe that private equity funders take advantage of them and that it’s essentially a win-lose game where investors win and entrepreneurs lose?
A bank loan is paid off over time whereas a shareholder has to be serviced in perpetuity or until that shareholder exits the investment. For this reason equity is expensive versus other forms of capital.
In addition, an equity investor is after the best return possible and will push the business to deliver on its promises. And, your investor will be looking to exit the investment for a profit once their own return criteria have been met. This may disrupt management attention in that they may need to buy those shares back at the now inflated price or spend time finding a replacement investor.
Essentially, if a business owner makes a bad choice, they will blame the private equity funder. But this can be avoided by reading the contract you sign, doing the due diligence, and ensuring that you understand how control of the business will change and shift.
Private investors do not simply make off with the value of your company. The key point here is that they make money only if the value of your company appreciates. It’s also a fact that, in most cases, the entrepreneur retains a substantial interest in the business.
After all, it’s in the investor’s best interest to help you grow your company and increase its value. If the investor wins, the entrepreneur wins.
What does an entrepreneur have to have in place to attract private equity?
The business needs to have demonstrated success and have a sustainable growth plan in place that can use assistance with professionalising infrastructure and project management and developing strategic execution skills.
The growth plan will be thoroughly analysed by the PE firm before they decide to risk their capital and management expertise. An entrepreneur needs to be thoroughly prepared to have his firm undergo a full due diligence, including strategic, operational and financial detail.
Often, entrepreneurs are extremely good at growing businesses up to a certain size, but they begin to struggle to deal with all the administrative necessities of running a much larger business. These include corporate governance policies and procedure, risk administration, financial systems and HR systems, to mention a few.
These policies and procedures are vital to minimise risk and ensure that plans can be efficiently executed. After all, if you can’t measure it you can’t manage it.
When is it the ‘right’ time to think about private equity for your business?
As a business grows, a revolving line of credit gives it the cushion it needs for working capital. Down the road, the company may have tens of millions in revenue.The founder sees new opportunities, but does not have the cash flow to finance new developments.
They may not want the burden of a bank loan, especially when the company itself may be worth quite a bit. Once the business reaches a level at which it’s stable, but lacks a growth agenda or the capital required to invest in expanding the business, it’s worth looking at a private equity partner.
Entrepreneurs generally reach out to private equity when their business needs capital from investors who are prepared to wait longer than a bank for their returns. The PE firm will also provide the business with strategic, structural and operational input to grow the business.
Most PE investors have plentiful experience with operating issues. Generally, they have little interest in micro-managing and are only too keen to look at the operation from an objective perspective. They can add value by challenging management to think differently from how they normally do.
Investors who have backed many different companies at rapid growth stages can recognise patterns that may not be obvious to the management team. They may also have a network of relationships that can help companies to recruit new talent at board and management level.
What do you need to know about letting go when it comes to PE?
Partnering with PE is not letting go, nor does it mean losing control. PE investors do not come in to run the business – they are backing entrepreneurs and management teams they think can deliver the growth objectives set for the companies in which they invest.
The entrepreneur will have to allow the PE team full access to its business plan and financial information. They have to understand that the PE firm as a shareholder has the right to guide strategy and execution plans.
To prevent conflict between the management team and the PE firm, entrepreneurs should perform an extensive due diligence on the PE firms and find the ones where there is a good fit in terms of both personalities and business objectives.
The entrepreneur needs to understand how long the PE firm intends to remain in the investment or what point return criteria will have been met. It is vital to have all expectations set right from the beginning. It’s critical to timeline the investment and set expectations with investors upfront.
Do not make the mistake of expedience – of being so determined to grow your business that you will accept any terms as long as you can get to market. Ultimately, you cannot make anyone responsible, other than yourself, if you agree to a deal and surrender control.
The reality is that if you sell a minority investment, you can continue to control your company, make all operating decisions, and have the ultimate say over strategic issues. Once again, remember that most professional investors do not want to run your company.
They are busy making their own money. By selling less than half of your company, you can remain at the helm, while providing liquidity for yourself, the company and other early shareholders.
When It Comes To Investors, the Less Risk the Better. Find Out How To Minimise It Here.
Does PE always mean that you will have to sell your company at some point?
The PE investor will always need to exit its investment – that is its business model. Since the firm has limited partners who expect liquidity at some point, they can’t hold onto their investment in perpetuity. Their exit is traditionally through either a sale or IPO. In many growth investments, the exit can be a sale back to management.
Alternatives might include recapping the company with bank debt, swapping out one investor with a new private equity investor, or raising capital from a strategic partner. The entrepreneur does not always have to exit as well.
Various exit scenarios should be discussed upfront in order to allow management to prepare for the exit.
Financial considerations should be included in the financial modelling to protect the entrepreneur’s business at the time of that exit.
What are the biggest pitfalls of PE?
Management clashes. Feelings of being interfered with. An important consideration is whether or not the PE firm will be expecting specific returns or dividends at specific times.
The entrepreneur needs to understand the implications of what will happen should these returns or expectations not be met within the required time period. The contract with the PE firm needs to clearly articulate action that will be taken for any foreseeable problem.
The entrepreneur also needs to ensure that remedies are in place should they wish to force the PE firm to exit at any particular stage. In worst case scenarios, the private equity investor buys control of the company, cuts lots of jobs, and loads the new company with a ton of debt.
Then they pay themselves huge management fees, and sometimes manage to cash out before the company turns around. That leaves other shareholders to suffer if the company doesn’t make it.
What tips do you have for companies looking to go the PE route?
Entrepreneurs should always do a due diligence on their prospective investors and select the one where there is the greatest organisational and cultural fit. You will be working alongside these people as partners over a number of years.
Getting a fair price for your business is certainly an important consideration, but it’s equally important to partner with an investor who shares your goals and who will work with you to achieve them.
If you focus only on the valuation of the business, you risk ending up with a partner who doesn’t understand your company, your growth strategies, or your industry.
If you sell to a private equity investor who has unrealistically high expectations of the company, the relationship is likely to sour when the business fails to meet the investor’s expectations. An investor with whom you can forge a sound relationship based on an in-depth and detailed understanding of your company will instead work with you to increase its value in a realistic and sustainable way.
It’s also imperative to align expectations of timing and exit upfront. Make sure you are ready to exchange equity in your company for funding and bring a new voice into strategic decisions. Failure to communicate openly with investors is often where you run into problems.
6 Great Tips For A Successful Shark Tank Pitch
Whilst most of us are unlikely to appear on television shows such as Dragons Den or Shark Tank there is a lot we can take out from watching these programmes.
Whilst most of us are unlikely to appear on television shows such as Dragons Den or Shark Tank there is a lot we can take out from watching these programmes. Entrepreneurs will often need to promote their businesses to prospective customers, lenders, investors, employees and even suppliers.
All stakeholders would like to know with what and whom they are dealing. They will need to assess risk and will try and evaluate the business against others who are competing for those same funds.
1Know Your Product
You should be able to describe your business within 60 seconds, in a confident and positive manner. Let the stakeholder know what particular problem your business solves which makes it viable and attractive.
Your brand and how you intend to develop it is important in determining whether they will invest or lend you money. Share critical information with them such as large customers, patents and trademarks and details of forward orders.
If you are looking for funding or investment, make sure you have the relevant paperwork to back up what you are saying.
You must have your numbers at your fingertips. A true and successful entrepreneur will know his numbers instinctively and be able to recollect and present them convincingly. Stakeholders want to know your turnover (sales) over the last couple of years, your gross profit and net profit.
Investors want to know what they are investing in and whether there is strong potential for their money to grow. Lenders will want to assess their risk — how are you going to repay the money? Moreover, you as the business owner, need to be sure that you will be able to make the required repayments.
You must know what your margin is, as this will largely determine your viability as a business. Margin or gross profit is the difference between the selling price of the goods and their cost and is usually expressed as a percentage.
3Know What You’re Asking For
Be clear as to the size of the investment you want to give away and how that determines the ‘valuation’ of the business. Therefore, if you wish to raise R200 000 for 10% of the business, that means you value the business at R2m — be sure you can back that up or you will get taken apart.
4Have a Business Plan
The best way to fully understand your business is by way of having a detailed business plan, which has been prepared whilst working through every facet of your business, from the original idea to the finished product.
As the business owner, you need to live this business plan and be able to use it as your daily guide to success. Develop it, change it where circumstances require it, but most importantly know it and understand it.
In this way, you will be able to deal with most of their questions, be they about marketing, research, international expansion etc. It is also a good idea to know your competition and what they are up to.
In most interactions, you the entrepreneur, are selling yourself. Whether it is an investor, lender, customer or prospective employee, it is their impression of you and your capabilities which ultimately determine whether they want to work with you.
Be confident, defend your position where required, as you will need to parry some blows but do not behave arrogantly.
6Learn From Your Mistakes
Many entrepreneurs who have presented to the Shark’s Den and not been able to garner investment have turned their business into great successes. You need to be able to learn from the experience, and if rejected, bounce back even stronger.
3 Things You Must Have In Place To Get That Start-up Bank Finance
If you’re planning to secure funding for your start-up, you need to put the right foundations in place.
The South African landscape for raising finance is tough for any business, with stringent lending regulations. Here are three areas to focus on as you set up your start-up to ensure you’ll qualify for a loan or equity funding.
1Securing a Market
Most SMEs I have mentored or advised start with expressing how big the total market size is for their product or service, but, while this is important to understand, the big question is: What percentage of that market will you attract and how?
Look at the ‘how’ first and work your numbers backwards. For example, if you secure a R10 million contract to supply an item that has a market size of R37 billion you are capturing only 0,03% of the market. However, if you’re able to cover your monthly expenses (including your loan repayment) and make a profit, that’s what counts. You should be able to show this contract or letter of intent to procure, which shows how and where you will find this market.
2A Strong Team
When you’re starting out you’re likely to be the sum total of your team. If you’re going down the entrepreneurial journey alone, make sure you have identified who will mentor and guide you through the areas you don’t have competencies in and cost this into the business start-up and running costs.
Focus on who in the business is going to:
- Sell and market: Do they have the necessary skill, network, product and market knowledge?
- Control the money: Are they financially savvy and can they make sure that money is being used for the right things?
- Operate: Who has done this before? Can this individual manufacture the product or arrange the supply of goods or services, ensure quality control and sound human resource management?
Formalising your business is costly but necessary. If you don’t have a formal entity, shareholders agreements, loan agreements, financial statements, management accounts, tax compliance and so on, you will come short when looking to raise finance.
Understand these costs upfront and include them into your start-up budget — this will save you a lot of pain in the long run.
The truth is that finance is available for women who have the right business ingredients just as much (if not more — in the South African context) as it’s available for men and just as with men. And, resources such as these help to unpack and guide the core fundamentals that are needed to make business bankable/fundable.
Then it’s all about implementation and staying on track to translate all that you’ve done and all that you wish to do in a bankable business plan, and approach the relevant funder for your needs. The right business mentor can certainly help you on that journey.
If You’re Trying To Raise Money, Doing Any Of These 9 Things May Scare Off Investors
Avoid these mistakes and funding could be yours.
Most new and existing businesses can benefit from outside funding. With such funding, they can grow faster, launch new initiatives, gain competitive advantage and make better long-term decisions as they can think beyond short-term issues like making payroll.
Unfortunately, though, most entrepreneurs and business owners make several mistakes that prevent them from raising capital. These mistakes are detailed below. Avoid them and funding could be yours.
Making unrealistic market size claims
Sophisticated investors need to understand how big your relevant market size is and if it’s feasible for you to eventually become a dominant market player.
The key here is “relevant” and not just “market.” For example, if you create a medical device to cure foot pain, while your “market” is the trillion-dollar healthcare market, that is way too broad a definition.
Rather, your relevant market can be more narrowly defined as not just the medical devices market but the market for medical devices for foot pain.
In narrowing your scope, you can better determine the actual size of your market.
For instance, you can determine the number of foot pain sufferers each year seeking medical attention and then multiply that by the price they might pay for your device.
Failing to respect your competitors
Oftentimes companies tell investors they have no competitors. This often scares investors as they think if there are no competitors, a market doesn’t really exist.
Almost every business has either direct or indirect competitors. Direct competitors offer the same product or service to the same customers. Indirect competitors offer a similar product to the same customers, or the same product to different customers.
For example, if you planned to open an Italian restaurant in a town that previously did not have one, you could correctly say that you don’t have any direct competitors. However, indirect competitors would include every other restaurant in town, supermarkets and other venues to purchase food.
Likewise, don’t downplay your competitors. Saying that your competitors are universally terrible is rarely true; there’s always something they’re doing right that’s keeping them in business.
Showing unrealistic financial projections
Businesses take time to grow. Even companies like Facebook and Google, with amazing amounts of funding at their disposal, took years to grow to their current sizes.
It takes time to build a team, improve brand awareness and scale your business. So, don’t expect your company to grow revenues exponentially out of the gate. Likewise, you will incur many expenses while growing your business for which you must account.
As such, when building your financial projections, be sure to use reasonable revenue and cost assumptions. If not, you will frighten investors, or worse yet, raise funding and then fail since you run out of cash.
Presenting investors with a novel – or a napkin
While investors will want to meet you before funding your business, they will also require a business plan that explains your business opportunity and why it will be successful.
Your business plan should not be a novel; investors don’t have time to wade through 100 pages to learn the keys to your success. Conversely, you can’t adequately answer investors’ key questions on the back of a napkin.
A 15- to 25-page business plan is the optimum length to convey the required information to investors.
Not understanding your metrics
How much does it cost to acquire a customer? What is your expected lifetime customer value?
While sometimes it’s impossible to understand these metrics when you launch your business, you must determine them as soon as possible.
Without these metrics, you won’t know how much money to raise. For instance, if you hope to gain 1,000 customers this year, but don’t know the cost to acquire a customer, you won’t know how much money you need for sales and marketing.
Likewise, understanding your metrics allows you and your team to work more effectively in setting and achieving growth goals.
Acting like know-it-alls
While investors want you to be an expert in your market, they don’t expect you to be an expert in everything. More so, most businesses must adapt to changing market conditions over time, and entrepreneurs who feel they know everything generally don’t fare well.
A good investor has seen many investments fail and others become great successes. Such experiences have made them great advisors. They’ve encountered all types of situations and understand how to navigate them.
If you’re seeking funding, acknowledge such investors’ experiences. Let them know that while you are an expert in your market, you will seek their ideas and advice in marketing, sales, hiring, product development and/or other areas needed to grow your business.
Focusing too much on products and product features
When raising funding, you need to show you’re building a great company and not just a great product or service. While a great product or service is often the cornerstone to a great company, without skills like sales, marketing, human resources, operations and financial management, you cannot thrive.
Furthermore, if your product has a great feature, be sure to specify how you will create barriers to entry, such as via patent protection, so competitors can’t simply copy it.
Exaggerating too much
When you exaggerate to investors who know you’re exaggerating, you lose credibility.
One key way to exaggerate is with your financial projections as discussed above. There are many other ways to exaggerate. For instance, saying you have the world’s leading authorities on the XYZ market is great, but only if they really are the world’s leading authorities.
Likewise if you say it would take competitors three years to catch up on your technology, when investors ask others in your industry, they better confirm this time period. If not, your credibility and funding will be lost.
What do investors care about? They care about getting a return on their investment. As such, anything you say that supports that will be welcomed.
For instance, talk about your great product that has natural barriers to entry. Discuss your management team that is well-qualified to execute on the opportunity.
Talk about strategic partners that will help you generate leads and sales faster.
But, don’t go off on tangents that don’t specifically relate to how you earn investors returns, like the fact that you’re a great tennis player.
Likewise, conveying too many ideas shows you lack focus. For instance, saying you’re going to launch product one next year, and then quickly launch products two, three and four, will frighten investors. Why? Because they’ll want to see product one be a massive success before you even consider launching something new.
Investors have two scarce resources: Their time and their money. Avoid the above mistakes when you spend time with investors, and hopefully they’ll reward you with their money.
This article was originally posted here on Entrepreneur.com.
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