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.
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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.
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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.
The Investor Sourcing Guide
How to attract and obtain investors to your established, high-growth business.
As an established, high-growth company, you may find that you need to source capital, identify a mentor, or work closely with other affiliates to prosper. In this case, partnering with an investment holding company can be a valuable growth tool.
So, what should you do if you want to be acquired by a holding company?
1. Research everything
If you’re considering a long-term investment partnership, make sure you conduct substantial prior research. There may be many potential investment partners out there, but each has specific venture and industry directives. Get to grips with these.
Related: Is Venture Capital Right For You?
2. Be candid with yourself
The amount of capital that you need will affect which holding company you choose. In particular, you’ll need to understand what your risk profile looks like relative to the returns you expect to provide. This will also help you to source, entice, and keep the attention of the most appropriate partner.
3. Identify your must-haves
Any investment partner you choose is likely to be able to provide you with funding, a broader network, and economies of scale. Beyond these, however, you’ll need to decide on your most important benefits (must-haves), so you can target the companies that can offer you the best fit.
4. Spell out your funding plan
You’ll need to be very clear on how you plan to spend the funding you get from your investor. This plan should stipulate, in particular, how you plan to grow.
5. Scrutinise each investor
Make sure to analyse your potential investors’ investment history, so you can get a clear idea of where your interests are aligned. Look specifically at things like:
- Where investors’ get their funding
- What their investment track record looks like
- What their investment directives are
- Their appetite for risk
- The returns they usually aim for
The crux of the matter
Research is essential, no matter which holding company you hope to be acquired by. This will help you to find, attract and retain an investor who gives you the funding you need, and lends you the support to be innovative, productive, and profitable.
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.
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