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Wednesday, January 9, 2013

Understanding the Principles of Private Equity Financing

Peter King
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Utilizing Private Equity to Grow Your Company

 

There are plenty of myths surround private equity investors. Some business owners, for example, fear that if they partner with a private equity group, it might make off with the value of their company by buying low and cutting them out of the rewards when it later sells the company at a premium.  

 

This kind of concern generally is unfounded. Private equity can be an excellent way to obtain the funds and expertise you need to grow your company. Before taking the leap, however, you should know the facts about these types of investors.  Do your homework.  Here are a few basics to get you started down the private equity path:   

 

Private Equity Basics

Private equity investors buy shares in a private company intending to help grow and, eventually, sell the business. Limited partners provide the funds, and general managers select and manage the investments.

Private equity groups usually take a controlling or significant interest in companies in one of three ways: 

  1. Venture capital. Here, investors focus on early-stage companies expected to produce strong revenue in a few years, or later-stage companies that are likely to generate increased profit in a year or two. Read more about venture capital.
  2. Buyout and acquisition financing. Private equity investors use a new business plan and, sometimes, new management to improve a company's financial performance. Read more about buyout and acquisition financing.
  3. Expansion or merchant banking capital. With this approach, investors focus on established companies expanding their operations or entering new markets.  Read more about expanding into new markets.
    Private Equity Diagram

Shared Control 

You can use the private equity group's cash infusion to launch new products, make acquisitions or pursue other growth opportunities. Selling your company to a private equity investor doesn't mean you have to lose control of it completely. Owners generally retain a substantial interest in the business and, thus, also benefit as the company grows and is eventually sold.

In fact, selling less than half of your company allows you to retain full control. Even if you keep only a minority interest, you may be able to work out an agreement with the investor that keeps operating and strategic decisions in your hands.

Early Exits 

 

Another misconception among some business owners is that private equity investors are only interested in their exit strategy. It's true that these groups realize a profit when they sell - so they can't be expected to hold on to an investment forever. However, they often will extend their support of a company over a period of five to seven years.

 

Importance of Expertise

 

Getting a fair price for shares in your company is vital to a successful private equity partnership. Before you seek financing, work with a trusted financial adviser to determine your company's current market value.   

But price shouldn't be your only criterion for a private equity partner. You don't want to give up a chunk of your business to a high bidder that doesn't understand your company and industry, and that may have unrealistically high expectations for growth. This type of relationship is likely to sour when expectations can't be met. Instead, VR advises that you partner with an investor that shares your goals and understands the challenges you face.

Many private-equity groups specialize in particular industries; therefore, we assist you in searching for one with multiple business investments in your sector. Expertise investing in similar companies means your partner may be able to recognize patterns that aren't obvious to your management team. The private equity group also can introduce best practices from other businesses and give you access to a network of professionals to help - from recruiting talent to business partners.

Understand Your Goals 

Private equity isn’t for everyone.  However, in the right application, private equity can provide the necessary funding and support to drive your company onto an entirely new level of performance and profitability. Private equity investors can help your business grow in ways that you would never be able to on your own. A thorough review of your strategic plan, the market environment and your other financing options will enable you to decide if private equity is a viable option. 

 

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