A private equity investment has the
obvious advantage of bringing money to a company. Most company owners
are not aware of all the implications – beyond the money – of
bringing on board a private equity investor.
Taking your
company to the next level
Private equity investors are
financially driven. They ambitiously target high levels of return –
generally an Internal Rate of Return of 25% or more. Shareholders and
managers must convince the private equity investor of the potential
and strategy for value creation, and management’s ability to
execute the strategy. Private equity can be a partner for taking the
company to the next level. For example, a private equity investor may
be an excellent partner for helping to take your company
international, or take it onto the stock exchange.
Mid-term
time horizon
Private equity investors do not want to be
invested in a company forever. A four- to seven-year time horizon is
typical. One of the first questions they will ask when considering
investing into a company is: “What is my exit strategy?” The lack
of a credible exit strategy is almost always a deal breaker. So don’t
expect private equity to be invested forever.
Management
must generally stay
Owner-managers looking for a total exit
will be disappointed. Private equity will generally want an
owner-manager to retain a significant minority interest in a
business, and to remain committed as a manager, for at least the our-
to seven-year investment cycle mentioned above. (One exception is
where private equity makes a “bolt-on” acquisition, where they
buy a company to add to one of their existing holdings).
Emphasis
on corporate governance and financial management
Very often
private equity investors will want to appoint the Chief Financial
Officer. They will want to have a properly constituted and active
board. Decisions will need to be well prepared, transparent, and
documented. This can be an important part of the maturation of a
firm. Private equity investors, via the board of directors, will want
to be involved in decisions with respect to strategy, business plans,
major investments, hiring or firing of senior staff, etc., while
leaving day-to-day operating decisions to management, so long as
management is performing according to plan.
“Carrots and
sticks” with respect to achieving plan
Private equity
generally allow for generous bonuses when plan is met or exceeded. On
the other hand, private equity will ask for the owner-manager’s
remaining interest to be diluted if the company does not achieve the
business plan provided at the time of investment. Also, private
equity investors generally insist on having the right to dismiss the
owner-manager (e.g. assuming he or she stays on as CEO), in the event
that plans are missed by a certain margin.
Drag along and
tag along rights
Private equity investors will often insist on
having the right to sell the remaining shares of the owner-manager at
the time they are exiting. Usually this type of clause only takes
effect after a good many years (e.g four or five years from the time
the private equity firm invests into a company). Before such period,
the parties may investigate options for the private equity firm to
exit without triggering the exit of the owner-manager, if the latter
does not wish to exit. In other words, the drag along rights may
become a default option, to be exercised only after a certain period
if private equity cannot exit without dragging the owner-manager
along. These provisions may be a problem for those owner-managers who
wish to hold their equity stakes for the very long term.
Variations
among private equity players
I do not mean to create the
impression that all private equity firms are identical. While most
will insist on taking a controlling interest, some will accept a
minority interest. While most will insist on injecting money into the
company, many will also buy shares of the current shareholder(s).
Some private equity funds are more “hands on” than others. Some
will have sector focuses and expertise. Some will be more compatible
with the personality of the current shareholder(s) and manager(s)
than others. Some will prefer larger or smaller transaction sizes
than others. It pays to do your research and talk to different
players.
In a nutshell, a private equity investor may be a
very appropriate partner for an owner-manager who has a reasonable
degree of confidence in achieving high growth in the value of his or
her firm with a capital infusion, and is willing to go along with the
aforementioned way of doing business of private equity investors. But
it is not for every business owner.
