In this article we discuss how private equity firms create value, how to prepare for investment, and more.
Unsure if Private Equity is right for your business? Try out our Investor Readiness Tool or learn more about the world of Private Equity with our Demystify, Navigate, Accelerate and Realising brochures.
What is Private Equity?
Private Equity - a term that is readily thrown around in the business world, particularly for startups, scale-ups, and later stage businesses, but it’s often misunderstood and associated with predatory investment firms looking to amplify their own ambitions - often at the expense of your business.
Private Equity can be an exceptionally positive route to growth, enabling businesses to expand at speed and with the resources, knowledge, and capital to support even the wildest of ambitions.
The investments Private Equity firms make into high-growth businesses can be both control and non-control positions. They can take the form of a purchase of shares from an existing shareholder (a ‘buy-out’ if control acquired) or an investment in new shares providing fresh capital (development or growth capital) - or a combination.
Each Private Equity fund will look to maximise investment returns and seek to create value in businesses with favourable themes, market conditions and growth prospects. They may invest based on investment target sizes, fund strategy, culture, or industry. All Private Equity funds share the common goal of driving transformational growth during a relatively short period of time (typically three to five years), resulting in significant returns for all shareholders.
Private Equity is best suited for growth oriented, later stage companies often pursuing further expansionary growth, ready to execute a full or partial exit for owners or those looking to optimise their capital structure.
For more information on other types of investment available for your business, read about Private Equity in Australia today.
How do Private Equity firms create value?
Private Equity firms create value in growth-oriented businesses by accelerating their value proposition in the market, enhancing cash conversion, and reducing risk. And in turn, it often culminates in a profitable exit within three to five years.
Areas of value creation include a focus on (but not limited to):
- Operational improvements (such as talent upgrades, cost reduction and financial engineering)
- New market entry (particularly product adjacencies and market expansion)
- New product development
- Risk management via better infrastructure and systems.
According to McKinsey, when Private Equity firms tackle pricing in their portfolio companies (the investees), there is typically a margin expansion of between three to seven percent in one year – this directly creates value for both the portfolio company and the Private Equity owner.
Private Equity investment also comes with the built-up knowledge developed from owned and divested assets, superior management deployment and, while it’s often seen as a negative point, the firm’s operational oversight is unparalleled and quite often necessary for portfolio companies who have not undergone the investment process and/or financial reporting rigour and change management previously.
Considerations for Private Equity
When a business is considering Private Equity, there are three main considerations we encourage you to discuss internally before starting the Private Equity journey:
- What is the business looking to achieve with the investment capital?
- How much investment is required?
- What external sources should this capital be raised from, and in which form – debt or equity?
Our Navigate brochure provides a roadmap for this complex and time intensive investment process, should Private Equity be the path that your business decides to take.
The main considerations in the investment process are to prepare for the following stages:
- Phase one – Exit readiness (three to six months)
- Obtaining stakeholder buy-in
- Preparing and identifying deal issues
- Assessing all funding options
- Phase two – Preparation (six to nine months)
- Agreeing on a deal approach and timetable
- Identifying risks and plan mitigation
- Preparing the deal materials
- Phase three – Marketing (nine to twelve months)
- Stimulating the Private Equity audience
- Driving competitive tension
- Obtaining offers
- Phase four – Deal completion (twelve to eighteen months)
- Closing a deal with a preferred Private Equity investor
- Receiving manager interaction of legal, tax and financial aspects
- Achieving optimal deal structure and vendor protections.
There are many more considerations that come into play when you prepare for Private Equity. We strongly recommend you engage with a Private Equity adviser prior to starting this process.
Are you ready for Private Equity?
Determining if Private Equity is right for your business starts with understanding what stage of your business you are in, understanding what success looks like for your business over the medium to long term, and understanding the alternatives available with a list of your ‘non-negotiables’ – terms you would never sign up to.
Private Equity may not be right for your business at this stage, but that doesn’t mean there aren’t other options for funding and growth. In our experience, the most important consideration is to have absolute clarity over your own objectives and those of your team.
Whilst we do recommend your EBITDA (Earnings before Interest or Taxes) to be $3 million to $5 million or above to attract the best pool of Private Equity interest, there really is no magic number or metric to determine when you are ready for Private Equity.
If you are unsure about whether Private Equity is right for you, try our five minute Investor Readiness Tool.