Private equity isn’t just for big business. Innovative, growing SMEs are often in need of capital to fund business growth, and private equity may be just what you’re looking for. Here’s how you can choose a private equity partner to grow your business.
These days, owners of small to medium businesses are now more likely to be approached by private equity investors—an inevitable consequence of the growth of funds in the sector. The money needs to be invested somewhere so the pressure is on to find suitable businesses.
If you are invited to talk to a private equity executive don’t, as some business owners have done, regard it as a threat and reject the invitation. Think of it as an opportunity. When private equity calls, call back.
If private equity makes an initial approach to talk to you—probably through an intermediary such as your accountant or business adviser—they might be contemplating making an offer for your business, but will more likely be researching your industry to gain a better understanding of the opportunities it offers. Such talks are likely to be to your advantage in the long run. For example, an initial approach could mean a firm is considering a consolidation play in your industry. If so, refusing to talk could result in you losing out on the opportunity for your business to be at the core of that strategy. Responding might enable you to be a partner and share in the success of the venture.
If private equity is interested in taking control of your business, take it as a compliment. You must be doing something right! Sure, you might have no interest in selling but keep in mind that old maxim: any business should always be for sale at the right price. It will always be better to know sooner rather than later how much private equity would be prepared to pay for your business, and what you can do to improve that offer.
Of course, any private equity investor would like to buy a business for less than its true value. That would make their objective of exiting within a few years at a high return so much easier to achieve. But it is unlikely that they would expect to buy cheaply in most industries in current economic conditions.
A Fair Private Equity Agreement
Getting a dollar value for 50 cents might have been achieved in some deals five years ago, says managing director of Gresham Private Equity, Roy McKelvie. These days, however, his firm expects to pay fair value. In fact, he says, he has no doubt firms have paid significant premiums to acquire businesses in some recent deals.
Increasing competition to acquire key businesses has forced private equity firms to pay higher earnings multiples, that being the usual way of valuing a business.
A private equity investor will usually maintain that if it invests it will be business as usual with the same executives running day-to-day operations. But in most cases the investor will also insist on taking a majority interest.
Don’t be discouraged by this. Holding a majority interest is, in most cases, seen as essential to protect the investment. The last thing a private equity investor will want to do is take day-to-day control of the business, but will regard it as essential to have the power to do so if necessary.
McKelvie says an important part of a private equity executive’s work is to keep in touch with owners and executives in businesses across the full spectrum of industries in which the firm might be interested in investing.
“Of course it’s difficult as there is never much time available, but it is important to keep in touch. I might call a contact or have a coffee with him and discuss what’s going on in his industry, and others. There is value in learning how things are done in other industries,” he says. “And, hopefully, I’ll learn something too.”
Private equity doesn’t only talk to the most ambitious big city business executives.
Head of private equity at AMP Capital Investors, Greg Smith, says most of his team’s deals are sourced through the widespread AMP network, often outside capital cities. A key to that success has been the team members’ ability to empathise with ‘down to earth’ people who have focused on building their businesses over many years.
AMP Capital Investors helps many of these people to expand their businesses.
Over time, he says, the long-time owners of many other businesses realise the need to develop succession plans and are introduced to the private equity team.
Most, he says, are then pleased to accept clearly presented plans that will allow them to access their equity while at the same time see their business stepped up to the next level.
Whatever stage your business is at, bear in mind that private equity deals are rarely done ‘out of the blue’. Usually a formal deal process will have been the result of an introduction made some years ago, occasional calls and a few casual meetings.
So, when private equity calls, do call back.
-Adrian Herbert is managing editor of Private Equity Media. This story is an edited extract from Australian Private Equity Review 2007, which may be downloaded free of charge from www.privateequitymedia.com.au
Buyout Option
Private equity partners may also become involved in a management buyout, which is the purchase of the business by its management.
A management team may not have the funds to purchase the business, so they can team up with an equity partner to fund the buyout. One of the bonuses of an MBO is the management team retain an equity interest in the business—as owners not just employees. This in turn creates an environment where the management team has more invested in the business, other than financial, and tends to create an environment where management is working together to pursue the same goals for the company.
When establishing an MBO, some of the things you need to consider include how much the business is worth, how much you want to invest, and a plan of exit strategies (for you and equity partners).
If you are considering an MBO or private equity partnership, be sure to talk to your financial services first.
