How to Get Private Equity Finance
Gaining the capital you need to expand your business can be challenging. When you have exhausted traditional methods of funding from bank loans to family investment, Private Equity Finance could be a way forward.
However, the dynamic, fast-paced operating environment of a PE-backed company can provide business owners with a unique opportunity to grow their business but it’s not for the faint-hearted, you need to make sure you are “Investment Ready“.
Managing a private equity-backed firm brings a unique set of opportunities and challenges for business owners. On the one hand, private equity (PE) owners provide a degree of freedom and generous compensation unmatched by publicly-held corporations; on the other, PE investors’ focus on results and their limited tolerance for under-performance can result in a rapid turnover of management teams if the interests are not aligned.
What is Private Equity Funding?
Let’s start by identifying what Private Equity funding is and what it is for. In essence, Private Equity Finance is capital that is not listed on a public exchange. Private Equity Finance is composed of funds and investors that directly invest in private companies.
The Goals of Private Equity Firms
PE funds use investor capital to buy and enhance the value of companies, which can involve both increasing the company’s growth and cutting costs. The goal is for the private-equity fund and its investors make money when a target company is sold.
How Private Equity Firms work
To succeed in private equity business owners must develop a transparent and collaborative relationship with PE owners, who are very hands on and expect answers to questions fast. The interaction between owners and company managers is most concentrated in the early months post-investment (when PE firms work closely with managers to implement strategic change, organisational redesign and processes to track performance) and later in preparation for an exit.
PE-backed boards are typically leaner than those of publically listed companies and have a significantly lower percentage of independent directors. The number and composition of the board reflect the company’s needs at different stages of the holding period, increasing in cases of struggling investments and decreasing with success.
Board members from the PE firm will come to their meetings well-prepared and informed and will expect the same level of commitment from others, making board meetings highly efficient and focused and will set a more rigorous pace, especially when compared to boards of Family businesses. They may include operating partners such as NorthCo Management with specific expertise who will engage with their portfolio companies at a more granular operational level.
How do Private Equity Firms Structure Deals?
With a typical funding structure resulting in a leveraged balance sheet, life as a Private Equity (PE) backed business carries a relentless focus on cash returns to ensure investor debt is serviced.
Understanding working capital pressures, liquidity and free cash flow is, therefore, a priority focus that needs to extend all the way up to Board level; it’s not just the domain of the finance team or the credit control department. Where banking covenants are involved, this immersion in cash management is taken to a whole new level of importance; tripping a banking covenant inevitably signals the end for the CFO.
Of equal importance to cash, returns are profit generation; reported EBITDA needs to be an accurate, consistent and robust metric. Most PE deals have some form of EBITDA multiple embedded in their valuation so it’s imperative that this metric is accurately reported and stands up to scrutiny on an exit process. In addition, the importance of quarter-on-quarter (and often month-on-month) EBITDA growth over the period of investment can also bring unique challenges to a PE-backed business. With a typical three to five-year investment horizon, it is not desirable for PE-backed businesses to start making sizeable investments in the latter stages of the journey as this diminishes the ability to convert such investments into suitable EBITDA returns in the appropriate timescales.
Business owners require a very different approach when they become a Private Equity backed business. Within family-owned or SME corporates, reporting and interaction can at times be irregular and unstructured, while at the opposite end of the spectrum, listed companies have formal and well-prescribed engagement with their shareholders on a regimented quarterly basis. Life within a Private Equity backed business is very different. Continual dialogue and interaction with your portfolio manager is an absolute must in a Private Equity backed business. Satisfying the thirst of investors for information on performance and explanations of issues, which to you might seem obvious, can be frustrating but will be expected. Being able to adapt to this very different environment brings an intensity and pressure not always experienced before by those not familiar with life in a Private Equity backed business.
For more information on how the NorthCo Management team can help your business through the Private Equity Funding process, you can read about our Investment Readiness Programme here or get in touch for an informal chat.
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