Navigating private equity: Identifying the ideal investor

Navigating private equity: Identifying the ideal investor

Private equity (PE) may provide a suitable funding solution for your SME if new or current management are hoping to acquire the business, or if existing shareholders are seeking an exit. Ensuring you choose the right private equity backer to work alongside will be crucial.

Here are some key questions we recommend asking yourself before signing on the dotted line.

What are your objectives?
Apart from purely financial, are there other resources you are looking to gain from your investor? PE investors should bring to bear strategic knowhow, significant commercial and financial expertise, management experience and a strong contact base, as well as the capital investment. Businesses benefitting from PE investment may be able to harness these to grow more quickly, based on more sophisticated and well-supported business planning.

Are you likely to require ongoing finance? 
The aim of PE funds is to achieve stable growth of their investment portfolio companies because their objective is to build value during the term of the investment. Typical investment terms for private equity are from three to seven years, which will give the management team time to implement a strategic growth plan. A well-funded PE fund may inject further funding after the initial investment, for example to fund acquisitions or refinance third party borrowings. 

Will there be a beneficial impact on the business’ reputation?
PE funds go through a rigorous process of due diligence investigation of businesses in which they invest. They want to be comfortable that there is the potential for growth during the investment term and are attracted to businesses with proficient management teams who have proven ability to generate that growth. Managing to secure PE investment can therefore be seen as an indication of the strength of the business and ability of its shareholders and management.

Are you interested in a business partnership?
With a stake in the business, the PE Fund’s interests are aligned to an extent with other shareholders’ and management’s because it will ultimately realise its investment only on a successful exit. The fund and its appointed board directors will therefore be keen to contribute to the development of the business and be incentivised to find solutions to any difficulties encountered by the business. The fund may have experience of similar difficulties with other portfolio companies and this experience could be of huge value. 

Which investor is right for you?
PE funds have very different investment strategies. A fund’s strategy will influence the size of its investments (both in relation to ownership share and financial amount), how involved it will seek to be in the day-to-day operational management of the business and its exit timetable. A business seeking PE investment should ensure its objectives match the profile of the fund. 

Sector expertise can be very important. Just as the PE fund will investigate its potential investments, a business seeking investment from a fund should carefully investigate the fund, not least by obtaining references to try to ensure it is the right fit. One way funds may be able to differentiate themselves is with sector expertise which may increase the extent to which the PE fund can contribute as a resource and as a business partner. There can be excellent publicity generated by well-managed publication of the fact that the business has secured the backing of a fund with known expertise in a particular industry – sending a positive message to the market. 

Preparation and practical steps
You should first identify and prioritise your objectives – which, as mentioned above, may not be limited to purely financial aims. Then the business will be in a strong position to select a PE fund that is on-board with those priorities. Having managed to secure investment and worked out the terms of the investment – it will be of critical importance to clearly enshrine the principles of that deal in the relevant documentation.

Aside from the commercial terms, the decision as to which PE fund will best suit a business should be based ultimately on which fund will best support management in growing the business and allow the business to benefit from the various advantages of choosing the PE route. In terms of practical steps, the key is preparation – enquire of your existing advisers if they know private equity funds that operate in the relevant industry and research funds that are active in your sector. The more information you have before seeking funding, the better chance you will have of picking the perfect partner.

By Oscar Horwich, Senior Associate
First published in Real Business, August 2016

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