a few features that distinguish PE/VC investing from other types when buying a business. It’s important to pay attention to these differences. Knowing
these facts will save you from a lot of wasted time and frustration and avoid
going down the wrong path.
Active Involvement in Overall
professional will be actively involved in identifying the investment,
negotiating and structuring the sale and monitoring the portfolio business
after the investment has been made.
person will serve as a board member and/or financial advisor to the portfolio
company. This contrasts from a money manager that will passively select and
retain stock and debt investments.
Limited Period of Investment
other kinds of investments, those that are private equity or venture capital
are not intended to be held for an indefinite period. Rather, they are to be
held for a limited number of years with the expectation that there will be substantial
growth in value following the sale.
PE/VC fund ordinarily has a limited term of usually 10 to 13 years, where it
goes through cycles.
investments are generally made during the first 5 years with value-added
monitoring and growth continuing for several years thereafter.
investments are sold within 3 to 7 years after the original one in the
investments are sold or distributed in kind to the investors within 10 to 13
years after the funds formation
investor normally does not intend to maintain long-term control over the
portfolio business or to build a career running it. Rather, they generally
evaluate alternative exit strategies when making the initial investment. Often,
the original investment documents contain the terms or at least the outline of
the PE/VC investor’s anticipated exit strategy. Hence, PE/VC investing is significantly
different from buying a company with the intent of managing it for the
indefinite future and profiting indefinitely from the operating cash flow
produced by the business.
Privately-Held Purchased Securities
being publicly traded, securities that are purchased through PE/VC investing are
generally held privately by a small group. When a PE/VC puts together a new
business start-up, the newly-formed company (“Newco”) is privately held at the
outset most of the time. If the target in a buyout is publicly-held before it
takes place, the new company formed to effectuate the buyout (“Newco”) is
almost always held privately immediately thereafter.
PE/VC makes a growth-equity investment in an existing company (“Oldco”), it’s
usually held privately. In those few circumstances where a PE/VC makes a
growth-equity investment in a publicly-held Oldco, the PE/VC generally buys a
class of Oldco securities that is not traded publicly.
example, where Oldco’s common stock is publicly traded, the PE/VC may buy
- Convertible preferred stock or
subordinated debentures that’s convertible into Oldco common stock;
- Non-convertible preferred stock or
subordinated debentures with warrants to purchase Oldco common stock.
a PE/VC investor infrequently buys garden-variety Oldco common stock that’s
publicly traded, they typically acquire such stock from Oldco in a private
placement subject to SEC restrictions and with special negotiated rights that
make the PE/VC’s stock different from Oldco’s publicly-traded common kind.
- Registration rights;
- Pre-emptive rights;
- Options or warrants to buy
additional Oldco stock at a fixed price;
- One or more board seats.
summarize, a PE/VC investment is normally made in a privately-held business. In
the relatively infrequent cases where the investment is into a publicly-held one,
PE/VC will generally hold non-public securities.
PE/VC’s exit strategy often involves taking the portfolio business public and
ultimately selling the PE/VC’s stock into the public market, trading of the
portfolio company’s stock is generally part of the game, not the opening
maneuver. Therefore, PE/VC investing is considerably different from buying,
holding and selling publicly traded equity securities.
State of Management Status Determines Decision to
Invest in a Portfolio Company
investor will only devote in a portfolio business after confirming that they
have a superior management team in place – or one has been recruited. No one
can induce the PE/VC investor to put their money behind a management team that has
received no vote of confidence, regardless of how attractive the product,
concept or business may be.
an attractive portfolio company has to have 3 key qualities:
- Superior management;
- Superior management; AND
- Superior management.
To put the
point simply: PE/VC should never back a portfolio company with weak management.
Investor will Seek Control of
Portfolio Company Early
investor will often seek control of a given portfolio business early on or at
the very least have board representation if nothing absolute is obtainable. The
reason for this lies from the view that the PE/VC investor sees itself as
providing important advice on financial and strategic planning and oversight
for the portfolio company’s management. This will add value to the investment
on top of simply supplying capital alone.