Private equity is a source of growth capital that can help small businesses grow and expand. However, there are some things that small businesses should consider before working with private equity.
For one, private equity firms are investors, meaning they have a financial incentive to push for aggressive growth plans to generate a return on their investment. This can lead to tensions between the startup and its management team.
Benefits
Private equity firms’ huge sums on their investments evoke envy and admiration. The firms’ aggressive use of debt, concentration on cash flow and margins, freedom from public company regulations, and the fact that they can exit investments within a short period all contribute to their high rewards.
However, not all private equity benefits are obvious to companies considering working with them. For example, private equity firms are often skilled at putting together highly motivated management teams to improve business performance. They may do this by offering new performance incentives or hiring seasoned finance professionals who can bring new vigor to the business. The firm’s ability to turn around a failing company is a major advantage over large public conglomerates, which are generally less able to revitalize underperforming businesses in their portfolios.
Private equity investors also have a strong incentive to increase the value of their investments in a short amount of time. This can involve dramatic cost cuts and restructuring that incumbent management may be reluctant to implement. Private equity firms have been known to remove companies from public exchanges, a move called de-listing.
Another benefit of private equity is that it can introduce new sales channels and international markets to a small business. This can lead to significant growth in revenue and profits. However, it can be difficult to work with private equity, as it requires giving up some control of the company to outsiders.
Risks
Despite the stereotypes associated with private equity, it offers an opportunity for startups and small businesses that have reached a certain point in their development to grow. However, it requires a founder to be prepared for the process. This includes a willingness to lose control of the company by selling a majority of the shares or by giving new partners decision-making power through the entrance of executive officers.
Unlike venture capital, one of the private equity rules is investing in already established or mature companies and managing them to increase their worth before exiting the investment years later. This may include drastic cost cuts or restructuring. For example, a private equity firm acquiring an underperforming public company may reduce its workforce and shut down locations. Private equity investors also often focus on boosting earnings through organic growth and acquisitions.
Moreover, private equity firms are highly illiquid. They make investments over a long period, often requiring significant capital in each company. It is challenging to rely on private equity to fund an entire business when necessary. Private equity investors are primarily institutional funds, such as pension and endowment funds. They also invest through funds managed by private equity firms known as limited partnerships. These limited partnerships typically contribute funding to the private equity firm and take a low level of risk in investments.
Preparation
Private equity firms invest in businesses that can grow quickly. They also prefer to buy profitable companies with good sales growth prospects. However, it is important to note that every investment comes with a cost. Although PE investors don’t charge interest like banks, they will push a business to maximize its profits before deciding to sell it. This can be a stressful time for a company.
Private equity is an increasingly popular source of financing for startups and small businesses. Its long-term perspective can be beneficial to companies that need support and stability. However, the increased use of private equity can also lead to more investor competition and higher valuations.
One of the main challenges for private equity firms is to improve management teams. This can be done by giving managers better performance incentives and allowing them to make decisions independently. Alternatively, private equity firms may acquire related companies and merge them. This can create efficiencies and synergies.
It is also important to understand the different types of private equity. There are a few common types: Series A, Series B, and Series C. Series A private equity investments are the most common for startups. This type of funding is usually used to expand production capacity, explore new markets, and strengthen working capital.
Negotiations
Private equity has grown into a global industry. Firms manage investment portfolios worth trillions of dollars. These firms raise funds from institutional investors such as hedge funds, pension funds, university endowments, and ultra-high-net-worth individuals to pursue a particular investment strategy. Private equity investors typically buy companies and make improvements to spur growth before selling them for a profit. This process involves a lengthy capital call investment period and debt financing, which increases transaction value by reducing the initial equity commitment.
Many small businesses fly below the radar of large multinational industrial or service conglomerates. They offer higher-quality customer service and niche products and services that large corporations need help replicating. This appeal catches the attention of private equity investors, who see a lucrative opportunity to increase revenues.
The negotiating process is rigorous, and every proposal is scrutinized closely by a PE firm’s investment team. Much research, background checks, analysis, cold calling, and networking go into shortlisting potential profitable deals. Then, the team presents these proposals to the PE stakeholders for consideration. A successful proposal may be considered immediately or undergo a revision involving consultancies. Ultimately, the best deals are the ones that generate substantial returns on the investments made by PE stakeholders.
