Private Equity Houses
You have a successful business and you know you are ready to make the next big move. You have a proven business model and you need investment to drive faster growth and expansion. You are looking at the options for securing that investment. Private Equity (PE) is one of the options open to you. The question is; is PE the right move for you and your business?
Despite the occasional negative headline, 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. Our research shows that in 2017, PE-backed businesses grew revenues by an average of 12% and grew their workforce by 8.5%.
BDO regularly holds ‘Private Equity Demystified’ events for businesses considering their next move. The events are about giving you the information and understanding you need to make an informed choice on PE. The events feature speakers from PE Houses and portfolio companies. BDO has also prepared ‘Private Equity Demystified’, detailed information about Private Equity and how it works.
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Exploring Private Equity
What do I need know about PE investors?
PE investors are looking for businesses with the potential to deliver a substantial return on investment in a relatively short time, typically between three and five years. 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 or houses, look for specific characteristics that point to a potential for fast growth in value. These include the macro-economic environment and micro-economic considerations such as value, growth, margins and cash conversion. PE houses will also look at the owner and the management team and a range of other factors.
Each PE house will place a different emphasis on these elements depending on their strategy, appetite for risk and approach to working with and supporting portfolio companies. This will affect how they value potential portfolio companies.
It is the job of your advisor to help you find the right PE partners for you.
What are the different types of Private Equity?
There are many different types of PE investor. Each type of PE investor will have an specific investment strategy and style. This can range from seed capital taking a minority stake in a company that is pre-profit, and sometimes even pre-revenue, to global investors, with multi-billion dollar funds, looking for UK-based targets. A good example of this would be the investment that CVC Capital Partners made in Formula 1.
Other types of PE investors include regional specialists, sector specialists, turnaround or transformational specialists, high net worth individuals and sovereign investment funds. Again, each will invest in a different way and have different levels of active involvement in the management of the business.
How does a PE deal work?
PE deals can take an almost infinite variety of forms with each having a unique structure, targets and incentives. The key is to understand that the PE deal will set a benchmark for returns on investment for investors. The management team will share in equity and value that is achieved above and beyond that benchmark. Failing to achieve the expectations of investors can lead to them becoming more active in the running of the business and making, sometimes drastic, changes to the management team.
Again, you should ask your adviser to help you understand the right kind of PE deal for you and your business.
What can I to do to prepare for PE?
If you do just one thing to prepare for a PE investment, make it defining your vision of success. What do you want to achieve for yourself and for your business? Is success about a monetary value or about what happens to your business and the people who work for you? This ‘definition of success’ will underpin all the important decisions and choices you, and other stakeholders, will need to consisder as you make your move to becoming a PE-backed business.
You will also need to prepare your business for PE investment. PE investment usually leads to substantial change to most aspects of a business as investors look to secure value growth and ultimately high levels of return on investment. You will want to prepare for Due Diligence by looking at a due diligence questionnaire to better understand the reporting requirements that you will have to meet. 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 will use PE investment to achieve value growth and the kind of return on investment that potential PE investor are looking for. The equity story is the foundation stone of any relationship with investor.
It will include an explanation of the opportunities for growth, how these will be achieved and who the potential buyers of the business might be when it comes to realising the gains the business has made.
Our experience is that maintaining alignment of both investors and management around the equity story is one the most important keys to achieving success through PE.
What is the “Debt story”?
Accompanying your equity story, you should also consider the debt capacity of your business, your ‘debt story’. If your business is able to take on much cheaper debt, your blended cost of capital can be reduced. This, in turn, makes it easier to grow the equity value.
The health warning here is that over-gearing your business is a sure-fire way of destroying value.
What if PE isn’t right for my business?
PE is not the only option for funding growth. There are other options with their own 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. Your business advisor should carefully consider all the options and be able to help you find the right funding for your business.