• Private Equity Evaluation

    Demystifying Private Equity


Is Private Equity right for my company?

Private Equity (PE) can be a fantastic experience that drives ambitious businesses to transform and grow fast. The potential rewards for management and investors alike are huge. The outcome is often a very successful, and valuable business.

The question is; is PE the right move for you and your business? Well, the answer is simple, if you have a successful business with a proven business model and are ready to make the next big strategic move to drive growth and expansion - Private Equity is worth exploring.

What are the different types of Private Equity?

For private companies seeking to grow their businesses, the quandary of choice can make the first steps of identifying potential investors a complex procedure.

In the table below, we illustrate ‘the universe’ of available Private Equity investors in Australia.

Venture capital Seed or early-stage often seek to sector specialise as investments are ordinarily pre-profitability or even revenue. Minority investor, backing a management team and the development of valued Intellectual Property.
Development capital Later stage, growth investors. Includes regional governmental or pseudo-government agency investment. Minority investors with certain key minority control rights. Passive investment style.
Family office Investment office of one or more High Net Worth individual(s) and associated family.  Focus is on diversification and reinvestment of wealth into a range of asset classes, which frequently includes Private Equity-type investment. Both active and passive investors via majority and minority stakes in multiple that are typically held for a longer period than other institutional investors.  Often focused on investment in sectors and businesses familiar to the underlying family.
Sector specialists Focus on key growth sectors as core investment hypothesis. Use of activist sector experts to drive strategy and target specific acquisition targets.
Regional specialists Regionally originated houses focused on specific geographies and regional industries. Local industrial knowledge and connections. Leverage local networks and relationships.
‘Middle-market’ specialists An active core of houses seeking transactions with a broad range of Enterprise Values. Focus on deploying target levels of investment capital per deal in attractive businesses. Will require control.
Buy and build A subset of the middle-market, focusing on the acquisition of core ‘platform investments’ upon which additional bolt-on acquisitions will follow. Use of industry experts arbitraging combination synergies and knowledge of sectors.
Operational / transformational specialists Seeking to transform suboptimal or underperforming businesses, which will typically be acquired at lower valuations. Use of operating partners to deliver transformational change, often including enhancement of management teams.
International inbound Overseas investors seeking acquisitions in Australia. Seeking complementary investments or geographic foothold in the Australian business environment.

What are Private Equity investors looking for?

Simply, PE investors are looking for opportunities with the potential to deliver a substantial return on investment in a relatively short time. The rule of thumb is that they aim to double their money in three years or, treble it in five years.
As a result, PE firms look for specific attributes that will indicate the potential for rapid growth. These include, but are not limited to;

  • The macro-economic environment
  • Various micro-economic considerations such as value, growth, margins and cash conversion
  • The management team

PE firms will then evaluate these factors relative to their strategy, appetite for risk and approach to working with and supporting portfolio companies.

How does a PE deal work?

Every PE deal is unique - each has a different structure, targets, and incentives.

In saying that, a universal attribute in each PE deal will set a benchmark for returns on investment for investors. If the benchmark is outperformed, the management team will share in the equity and value that is surpassed.

Conversely, in the event of underperformance against those agreed benchmarks, it can lead to investors becoming more active in running the business and making - sometimes drastic - changes to the management team.

You should ask your BDO advisor to help you understand the right kind of PE deal for you and your business.

What can I do to prepare for Private Equity?

A clearly defined vision for the success of your business is vital to the preparation of a PE deal. Clearly articulating what you want to achieve and what constitutes success underpins all the important decisions you, and other stakeholders consider; as you make your move to becoming a PE-backed business.

Secondly, PE investment usually leads to a substantial change in most aspects of a business. As such, you will want to prepare for due diligence. This can be initiated by completing a due diligence questionnaire, to better understand your reporting requirements. You should also check that your tax and financial structures are as efficient as possible.

What is the ‘equity story’ or investment hypothesis?

Your equity story is the explanation of how your business intends to use PE investment to achieve the growth and return on investment that potential PE investors are looking for. The equity story is the foundation of your relationship with a potential investor.

The equity story will include an explanation of the opportunities for growth, the strategies to facilitate success and finally, who the potential buyers of the business might be when it comes to realising business gains.

What is ‘Debt story’?

Complementary to your ‘equity story’ is the ‘debt story,’ which evaluates the debt capacity of your business. If your business can take on cheaper debt, your blended cost of capital can be reduced. This, in turn, makes it easier to grow the equity value. The warning here is that over-gearing your business is a sure-fire way of destroying value. It equally needs balanced consideration.

What if Private Equity is not right for my business?

PE is not the only option for funding growth. There are other options with their advantages and drawbacks. These can include loans, venture capital, public markets, IPO, retained earnings and even friends and family. These may be better suited to your business strategy and goals.

With all these considerations, it’s the job of your BDO advisor to help you find a compatible PE firm that’s right for you.At BDO, we can assist you when considering your options and help you find the right funding solution for your business.