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.
3 Components Of The Perfect Elevator Pitch
Can you clearly demonstrate value when faced with a time crunch?
After filming two seasons of Entrepreneur Elevator Pitch, I’ve come to realise that there are three key elements to delivering the perfect pitch.
Our show is unique when it comes to pitching: Potential entrepreneurs have just one minute to pitch their idea, service or product. Those 60 seconds have added pressure because the contestants are being filmed, and they are talking to a camera (instead of people) while riding up to the penthouse suite in an elevator.
In real life, with a different set of distractions, it’s essential to know how to deliver a convincing elevator pitch. Whether you are pitching a product, a service or yourself, here are the three essential components in a pitch:
- Stimulate interest
- Transition that interest
- Share a vision.
Can you stimulate interest?
The first step, stimulating interest, is the most important. In fact, an “elevator pitch” is usually determined by the limited amount of time you have, and circumstances may only give you the opportunity to stimulate interest. If you do a good job of stimulating interest, this can yield a second opportunity, where you transition that interest and share a vision with those you are pitching to.
Keep in mind that people generally buy based on emotion, using logical reasons as their impetus for action. So, make a point to connect with them emotionally in order to stimulate their interest. Don’t be afraid to show your feelings; demonstrate high energy and excitement for your idea, business or service. Your passion and belief need to come through in your pitch!
Use the 100/20 Rule to your advantage: Have the energy that you are providing R100 worth of value and only asking for R20 in return. This attitude will generate enough attention, giving you the opportunity to transition the interest that you’ve garnered.
Make the transition
But people don’t buy exclusively on emotion. There needs to be some logic in the decision to make a purchase. Therefore, you must address some sort of pain, fear or guilt in your pitch, that those without your product or service may experience. And if you can illustrate how you (efficiently) solve a big problem, you’ll have more statistical success in your elevator pitch.
Making a genuine connection can help you transition interest. Learn to make yourself equal, then make yourself different.
Simply having connections to the same people or a point of similarity in your backgrounds will help bridge the gap with those you are pitching. Then you can emotionally connect, following that up with the logic portion of your pitch.
Transition the interest you’ve generated with a clear explanation of what differentiates you. Build credibility by discussing your sales, distribution, revenue, awards and/or successes. All of these different ways to “attract” allow you to segue from emotion to the logical reasons to buy.
Of course, it is of the utmost importance to be honest when you are pitching. The truth always comes out, so ensure that you aren’t over-promising with your pitch. Don’t create a void that you are unable to fill.
What’s your vision?
Finally, in order to excel when sharing a vision, you need to have a value proposition that backs the 100/20 Rule. Make the value that you bring to the table as clear as possible. The value you’re asking for in return also needs to be clear. If you don’t display confidence in what you’re asking for, you won’t instill confidence in those you ask.
Tell others exactly what you want, why you want it and what you’re willing to give in return. You should have already proved your valuation when transitioning interest, then reiterated that valuation as you progressed in the pitch.
Take the people you are pitching through the reasons why you can be of value to them, the impact that you can have on their life or organisation and the capabilities you (or your product/service) possess that makes working together beneficial for all involved.
Practice your pitch, then get rich
After following each of these three steps, close with one simple question to gauge whether you are aligned or not: “Can you see any reason you wouldn’t want to move forward?”
If you utilise your pitch to stimulate interest in your product/service/self, transition that interest, then share a vision with those you are pitching to, the answer is almost always a resounding “no.”
And if you get objections or rejections, so what? Address whatever objections there are and if you still can’t get aligned, that’s OK. Take the perspective that the universe has a set number of rejections you need to get to before you find the right partner.
Related: How To Pitch
Be grateful for an opportunity to prove others wrong, and believe that if you keep working on your pitch, product, service or self, everything will come to you in the right way at the perfect time.
This article was originally posted here on Entrepreneur.com.
Alan Knott-Craig Answers Your Questions On Finding a Funder To Managing Your Staff
What you really need to know to land an investor.
Focus on one customer at a time. Make that customer happy. Move to next customer. Aim for ‘1 000 true fans’, then keep them happy.
The rest will come.
1. How do I find an investor?
You have 4 options:
Applicable if you only have an idea, and you need cash to make your idea a reality. Usually between R500 000 and R1 million. You need to milk your network: Parents, friends of parents, colleagues, parents’ friends, friends. If you have no network, you need to build a network or use your savings. There is no math to these investments. You get money because they believe in you, not because they seriously expect a return.
2. Early-stage VC
Applicable if you already have a working product with traction, ie: users and/growth, and you need cash to build out. Usually between R1 million and R2,5 million. There are a number of early-stage VC’s in South Africa, just ask around. Knife Capital are amongst the best. Ideally you want an introduction from a trusted party. Failing that, just email them directly. Give a simple pitch. They’re looking for 15X return on investment.
3. Late-stage VC
Applicable if you have a critical mass of users and meaningful revenue, ie: R10 million a year, and you need cash to grow. The late-stage VC’s are the likes of 4Di, hard to get access without an introduction from a trusted third party, usually one of your existing investors. They are looking for a 5X return on investment.
4. Private equity
Applicable if you have a cash-generative business that requires capital to either exit a shareholder, or to grow profits exponentially. Looking for 25% IRR.
There are also state-sponsored sources of capital for entrepreneurs from previously disadvantaged backgrounds, for example the Technology Innovation Agency. This is ‘soft’ money, requiring no equity or personal surety. If you can get it, take it.
Investors are looking for return on capital. If I invest R100 in an early stage company, I want to get R1 500 (15x) back within a reasonable period of time, ie. no longer than five years.
The key metric is Total Addressable Market (TAM). The size of the market you’re targeting determines the potential size of your business.
Assume you target a market with a TAM of R100 million (profit), and you assume you can get 10% of that market by 2020. That means your business will have R10 million of profits in 2020.
A private company is valued at a maximum of 7x profit, so your company will be worth R70 million in 2020. If you ask me to invest R1 million today, I need 21% of your company in order to realise a 15x return (R15 million) by 2020.
Start with TAM, work from there. Remember, every assumption you make will be questioned. Minimise your assumptions. Maximise the evidence for your assumptions.
2. If you are a start-up, what’s the most important thing you can do to grow?
Focus on one customer at a time. Make that customer happy. Move to next customer. Aim for ‘1 000 true fans’, then keep them happy.
The rest will come.
For consumer products, always make it easy for your customers to share. Friction-free sharing is the easiest marketing tool you can have.
Feature-creep is a big risk and can be a big distraction. You need one single value proposition that is enough to get customers. Having fifteen cool features will never compensate for the lack of one killer use case.
3. Our staff is growing, more than 20 now. Any tips on management?
Having four or five staff is not hard. You don’t need to be a good manager or leader. You can muddle along. It’s when your team starts growing past the twenty number that management becomes a skill rather than a word.
There are hundreds are articles written on the art of management, but Jack Welch (former GE CEO) broke it down to this:
- People want to know who they report to.
- People want to know how they’re being measured.
- People what want to know how they’re doing.
- That’s it.
- One boss. Clear KPIs. Regular feedback sessions.
Alan Knott-Craig’s latest book, 13 Rules for being an Entrepreneur is now available.
What it’s about
It’s easy to be an entrepreneur. It’s also easy to fail. What’s hard is being a successful entrepreneur.
For an entrepreneur, there is only one important metric of success: Money. But life is not only about making money. It’s about being happy.
This book is a collection of tips and wisdom that will help you make money without forgoing happiness.
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Do you have a burning start-up question?
XPRS Capital Africa Bridges Funding Gap Faced By South African SMEs
XPRS Capital Africa answers local SMEs call for funding.
Small and medium enterprises (SMEs) are a vital component of the South African economy. However, there is a substantial portion of the country’s estimated 650,000 SMEs that have no access to funding to assist in their continued growth
In response to an increase in demand for reliable and easily accessible capital for businesses like these, XPRS Capital Africa opened its doors in South Africa. The specialist business funding provider is geared towards rapidly vetting and approving short-term business funding ranging from R50,000 to R500,000. In addition, XPRS Capital Africa specialises in extending funding to SMEs that may not qualify for funding from traditional lenders.
Simon Leps, CEO of XPRS Capital Africa explains that XPRS Capital has its roots in the US, having been founded in 2013. “The company is a renowned and established alternative online business-to-business lender. Together with a team of data scientists and using thousands of data points, XPRS Capital has developed a proprietary credit vetting algorithm and packaged product set.”
“The technology and approval processes developed by XPRS Capital has a massively successful track record overseas and the experience that our company has gained over the years will help many more SMEs in South Africa to reach their potential,” says Leps.
“The XPRS Capital platform has processed over $1b worth of loans and has a proven track record of funding thousands of businesses across hundreds of industries,” he continues.
Leps adds that the company’s sophisticated algorithm allows XPRS Capital Africa to provide funding to many South African SMEs that are usually denied loans on the basis that their owners have less than ideal credit records. “Traditional lenders are often reluctant to lend capital to SME owners whose credit histories place them in higher risk categories. This has created a massive challenge for many promising SMEs. At XPRS Capital Africa, we focus on the health of the SME, and use state-of-the-art technology to provide businesses the cash flow they need to grow and flourish.”
Using the unique algorithm that we have optimised for the South African market, we are able to accurately assess any SME that has been in business for over a year, to rapidly provide a 3 to 12-month funding solution, notes Leps. “The online application takes less than 10 minutes, allowing SME owners to spend less time filling in forms for funding, and more time on their business.”
XPRS Capital Africa provides funding directly, working closely with SMEs to offer the fastest approvals, best possible repayment terms and most accurate risk profiles for any business.
“Cash flow is the lifeblood of every single business. Our mission is to provide this quickly, affordably and reliably,” Leps adds.
He notes that, given the high number of businesses that have trouble accessing financing, SME owners should also know how to maintain their own positive credit records. Thereby they can ensure that their businesses have access to as many options as possible.
“Ensure that all areas of your company are looked after to the same degree as most funding providers want to see that all aspects of a business are well managed. Up to date, audited financial statements and management accounts, well managed bank accounts, and good budgeting and forecasting show that the owners are attentive. Owners also need to know their businesses inside and out and be able to answer questions about their cash flow and deal pipeline.”
Related: The Investor Sourcing Guide
In addition to this, Leps says that the customer’s experience when dealing with the business could also have a measurable impact. “Any touchpoints that are available to your customers will be looked at by potential funders, so all customer facing assets should look professional and be kept up to date. This goes for websites, online portals and social media accounts.”
“The ability to access additional funds when your company needs it is the key to long-term survival. That’s why it is paramount to maintain the best possible credit record. However, it is also important to remember that, whatever the financial state of your business, business owners are never completely out of options,” Leps concludes.
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