Private Equity – Looking for Fine Answers

Private equity firms (and other financial investors) have always had an air of mystery about them, particularly for business owners who haven’t raised capital before. With press coverage usually biased to bad news stories, many owners assume the worst when considering financial investors as an option to exit or grow their business.

As mentioned recently in the AFR, “in the US, around 10,000 companies are in the hands of private equity at any one time. In contrast, the number of public companies peaked in the mid-1990s at around 8,000 and are now only about half that, while private-equity companies have quadrupled over that period”. This growth in financial investors has expanded the universe of potential growth and exit options for founders.

Background

Private equity as we know it today was conceived in the late 60’s. There was an increase in popularity of so-called ‘bootstrap’ investments which targeted family-owned businesses, many of which were founded in the years following World War II and were facing succession issues. Many of these companies lacked a viable exit for their founders as they were too small to be taken public and the founders were reluctant to sell out to competitors.

Today, there are a range of financial investors available to business owners, depending on the owner’s objectives. Private equity can be defined in different ways including:

• By investor type – including Venture Capital, Private Equity, Family Offices, and case by case investors;
• Within each class – funds typically have a broad style (growth capital, distressed / special situations, yield / patient capital); and
•  Based on the fund’s style – investors will typically have a range of criteria for “ideal” investments, including time horizon, sector preferences, cheque size, and the use of leverage.

Crucially, it’s important to recognise that, as with any investor, each financial investor will have its own personality. This is typically driven by the founders and reflects their background, however within each fund, there will be different personalities charged with making investments and subsequently executing the strategy. It’s important for owners to choose a partner who is likely to complement their own style and the specific requirements of their business.

What do PE look for?

We regularly present targets to financial investors to assess interest and fit. Generally, financial investors will assess the target within the context of either a new platform or as an add-on to a current investment. It is important to understand the investor’s rationale for acquiring your business, as this drives the outcomes and structure of the transaction.

Most financial investors are seeking to back existing management teams and will want the owner to keep some “skin in the game”. This helps align the seller with the buyer for driving future growth and to effectively put a seller’s future growth story to the test.

What do sellers need to know?

While every transaction is unique, there are a few tips to maximise your chances of succeeding with a financial investor:

• Identify the financial and non-financial objectives of the shareholders before starting the search;
• Meet early with a few different types of investors to start building the relationship and understand their style. As an example, in our recent transaction between Hall Contracting and Crescent Capital, multiple offers were received from private equity and strategic investors. The shareholders of Hall opted to partner with Crescent largely based on cultural alignment and shared views on the growth opportunities for the business;
• Understand what each investor brings to the table – a chequebook, access to C suite managers, experience in growing businesses (including in your sector), international relationships, etc. For example, in our recent transaction between Frosty Boy and Advent Partners, one of the key drivers for Frosty Boy was Advent’s experience taking its previous investment in Gourmet Gardens into international markets;
• Talk to their other investee companies, ideally ones that have gone well and ones which haven’t;
• If you get to a stage where there a multiple offers, systematically weigh up the pros and cons of each against the shareholder objectives set at the beginning of the process;
• Consider both the upfront price, and the potential return on the secondary exit. Can the investor help you accelerate your strategic objectives and grow the business so that you get a smaller piece of a much larger pie?

Ultimately though, a large part of the decision comes down to gut feel – can you work with the people every day for the next 5 years?

Summing it all up

A founder’s success in dealing with financial investors will largely be driven by their ability to identify the investor with the right fit for their strategic objectives. Firms each have their own style of managing their portfolio companies, their own skillsets, and personalities they bring to the table. In the biggest transaction of your life, it is important that you choose the right fit.

Authors: Michael Kakanis & Mark Steinhardt