Private equity isn’t just for big business. Innovative, growing small and medium businesses are often in need of capital to fund growth, and private equity may be just what you’re looking for. Here’s how you can benefit from bringing in a private equity partner, and how to choose the right one.
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.
Fair Deal
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
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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.
Finding Investment Partners
There is no substitute for spending time with your potential private equity partner—the business is choosing a partner that will be very influential over future outcomes, writes Jeremy A. Samuel.
How do business owners find the right private equity partner? Different private equity firms focus on different sorts of businesses although there are some common themes. While Australians often use the terms venture capital and private equity interchangeably, venture investors will usually look more to early stage businesses whereas private equity investors will usually look for more mature, established businesses.
Private equity can help management teams to acquire businesses from founders through management buyouts (MBO). The new capital structure can then help those businesses to grow organically or by acquisition. Examples include ACL (Australian Centre for Languages), Netti and Godfreys.
Divisions of larger businesses that are not core to the overall company strategy are also often suitable private equity targets. Repco, Accantia/Swisspers, and John West are Australian examples. More recently, we have been seeing that ‘undervalued’ public companies (such as Just Jeans, Flight Centre, and Coles) can attract interest from private equity buyers.
Further, earlier stage venture capital investing can support companies with rapid growth needs such as technology companies (for example, Comtech, Hitwise, and Resmed).
So what do private equity firms look for? Their investment criterion vary. However, most private equity firms look primarily for a team of proven, honest managers who have established a good record operating the actual (or similar) business and can align their interests with investors.
Industry stability and strong business cash flows are generally attractive and will often lead to a more leveraged capital structure. This combined with substantial growth potential can enabl
e the investor to feel more comfortable with the price for the business. However, a reasonable entry price having regard to the above factors and the future exit prospects is always important. Finally, good private equity firms will also only select companies where both they and the management team agree that the private equity firm can provide strategic and financial assistance and counsel to the business to deliver on its strategy. This is difficult to measure and often comes down to the fit between the individual personalities.
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The Right One
So, how does a business owner find the right private equity partner?
Given the importance of fit, there is no substitute for spending time with your potential private equity partner. This is a more important decision than choosing a service provider–the business is choosing a partner that will be very influential over future outcomes.
All stakeholders, including management, vendors and financiers, need to have confidence in the private equity firm to deliver on expectations. Criterion for choosing appropriate firms often include:
• credibility, integrity and ability to maintain confidentiality
• ability to structure and fund the transaction
• transparent and speedy investment approval process
• complementary fit with management including ability for the private equity firm to add strategic and financial value to the business.
Understanding the investment criteria of each private equity firm can make this matchmaking exercise more efficient. Credible firms generally make their market focus reasonably clear on websites and other publicly available information. For example, a firm such as Anacacia Capital can’t invest in start-ups. Other firms focus their efforts only on start-ups or early stage ventures.
When should a vendor consider approaching a private equity firm?
MBOs usually result from succession issues within private companies or from parent companies wishing to divest non-core assets. Engaging an adviser to run a sales process involves inviting several trade buyers and financial investors to tender their interest. While such competitive tension can maximise the likely price, it may also risk sensitive information falling into competitors’ hands. If not run correctly, this may tarnish the business, particularly in the case of an aborted sale.
Alternatively, vendors may enable a private equity firm, either with existing or new management, to have a preliminary look at the business. If they can meet the vendor’s price expectations, then they can enter into exclusive arrangements to complete more detailed due diligence and documentation.
There are several advantages of a vendor approaching a private equity firm in the first instance, particularly where the following factors are important:
• management may understand the potential business value better than other parties and will require less due diligence
• the confidential process minimises the chance of damaging information leaks
• there is flexibility to move later to an auction sales process if private equity doesn’t proceed
• they wish to reward loyal staff (particularly common in private businesses)
• MBOs can often be more acceptable to other stakeholders, including competition regulators, the broader workforce, customers and suppliers.
While there are distinctions between private equity firms, there are probably more similarities. The basic investment criterion of backing proven management teams in businesses with strong potential is a repetitive theme. Similarly, companies will generally be well advised to seek private equity partners that are willing to pay a ‘fair’ price and have the reputation and potential to help their businesses grow into the future. However, despite all the best quantitative analysis (and good private equity firms do a lot of this!), the end decisions often come down to personality fits and qualitative judgments about people’s honesty and capabilities.
* Jeremy A. Samuel is managing director of Anacacia Capital and chairman of its investment committee. Anacacia Capital invests alongside proven management teams in established small-medium enterprises. This article is an introduction to a complex, dynamic area and is not intended to be a substitute for independent advice or to represent the views, opinions or advice of the author or his employer.
