Last updated:
Private equity (‘PE’) provides typically medium to long-term committed share capital to help Companies grow and succeed. If you are looking to start up, expand, buy into a business, buy out a division of your parent company, turnaround or revitalise a company, private equity could help you to do this. Obtaining private equity is very different from raising debt or a loan from a lender, such as a bank. Lenders have a legal right to interest on a loan and repayment of the capital, irrespective of your success or failure. Private equity is invested in exchange for a stake in your company and, as shareholders, the investors’ returns are dependent on the growth and profitability of your business. Therefore, private equity investment also requires a previous due diligence and certain investment protection mechanisms (e.g. regarding the company´s decision-making process and transfer of the shares) in exchange of being more present in the management of the company.
Venture capital is a form of PE and a type of financing that investors provide to startup companies and small businesses that are believed to have long-term growth potential.
Private equity financing has some distinct advantages over other forms of funding. Here are some of the main benefits:
Large amounts of funding
PE firms have deep pockets and can provide the financial resources to fuel growth. These companies may provide the capital needed to build a new facility, buy new equipment, or launch a marketing campaign
Expertise and connections
PEs can supply the talent your company may be lacking. These are typically hands-on firms who will assist you meet new business goals and maximize company value. They provide experts who will work alongside you, whether that means launching online distribution, securing a government contract or filling some other essential need in your business.
Additionally typically PE firms are well connected in the business community. Tapping into these connections could have tremendous benefits.
Aligned incentives
Because private equity firms are investing their money in your business, they share responsibility for the way it is used and what kind of return they will get. They want your business to succeed, so you can count on them to care and help in any way they can. As such, PEs may be willing to get involved and intervene in your business’ operations, lending you their skills, expertise and access to useful contacts. Their involvement could also prove invaluable in helping you make key business decisions and develop an effective strategy, allowing you to benefit their knowledge and experience.
Pre-IPO step
PE funding may be a pre-step for an IPO given it will best prepare the company for a public life since:
► PE investment leads to the professionalization of the management team;
► PE investors will require the company to have in place reporting systems and discipline to present to them the company’s results.
The expertise of the PE may also be helpful to enhance your company’s valuation prior to the IPO as well as to navigate the company into the public offer process.
How do I select the right private equity firm?
Some private equity firms manage a range of different funds in which their companies’ investment preferences may differ. These preferences are normally presented on the PEs’ website.
If you decide to hire a financial advisor for the purpose of obtaining funding, he may be able to introduce you to their private equity contacts and assist you in selecting the right private equity firm.
The most effective way of raising private equity is to select just a few PEs to target with your business proposition.
The key considerations to assess the best PE to target are as follows:
► The stage of your company’s development or the type of private equity investment required.
► The industry sector in which your company operates.
► The amount of finance your company needs.
► The geographical location of your company’s operations.
If you are looking to raise funding from a PE, you should approach the entities whose investment preferences match your situation.
***Stage/Type of investment***
The terms that most private equity firms use to define the stage of a company’s development are determined by the purpose for which the financing is required.
► Seed – To allow a business concept to be developed, perhaps involving the production of a business plan, prototypes and additional research, prior to bringing a product to market and beginning large-scale manufacturing.
► Start-up – To develop the company’s products or services and fund their initial marketing. Companies may be in the process of being set up or may have been trading for a short time, but not have sold their product commercially.
► Other early stage – To initiate commercial manufacturing and sales in companies that have completed the product development stage but may not yet be generating profits.
► Expansion – To grow and expand an established company. For example, to finance increased production capacity, product development, marketing and to provide additional working capital. Also known as “development” or “growth” capital.
► Management buy-out (MBO) – To enable the current operating management and investors to acquire or to purchase a significant shareholding in the product line or business they manage. The amounts concerned tend to be larger than other types of financing, as they involve the acquisition of an entire business.
► Management buy-in (MBI) – To enable a manager or group of managers from outside a company to buy into it.
► Replacement equity – To allow existing non-private equity investors to buy back or redeem part, or all, of another investor’s shareholding.
► Rescue/turnaround – To finance a company in difficulties or to rescue it from receivership.
► Refinancing bank debt – To reduce a company’s level of gearing.
► Bridge financing – Short-term private equity funding provided to a company generally planning to float within a year.
***Industry sector***
Most private equity firms will consider investing in a range of industry sectors – if your requirements meet their other investment preferences. Some PEs specialise in specific industry sectors, such as biotechnology, IT and other areas. Others may actively avoid sectors such as real estate.
***Amount of investment***
Most PE firms have a ticket size preferences that may greatly differ between hundreds of thousand of euros to millions of euros.
Companies initially seeking smaller amounts of private equity are more attractive to private equity firms if there is an opportunity for further rounds of private equity investment later on.
The process for investment is similar, whether the amount of capital required is €100,000 or €10 million or more, in terms of the amount of time and effort PEs need to spend in appraising the business proposal prior to investment. This makes the medium to larger-sized investments more attractive for PE investment, as the total size of the return (rather than the percentage) is likely to be greater than for smaller investments, and should more easily cover the initial appraisal costs.
***Geographical location***
There are Portuguese PEs and foreign ones operating in Portugal. However, a Portuguese company is not limited to these, since big PEs invest worldwide and they might be the ones matching your level of ambition and open to your company’s specific situation. In a globalized and digitalized world, funding opportunities may be sought anywhere.
How should I prepare before approaching a PE firm?
Before approaching PEs a Business plan should be prepared to market your company’s business proposal. This document should show potential investors that if they invest in your company, you and your team will give them a unique opportunity to participate in making an excellent return.
A Business Plan should be considered an essential document for owners and management to formally assess market needs and the competition; review the business’ strengths and weaknesses; and to identify its critical success factors and what must be done to achieve profitable growth. It can be used to consider and reorganise internal financing and to agree and set targets for you and your management team. It should be reviewed regularly.
The shareholders or the managing director of the business should be the ones who takes responsibility for the business plan preparation, but it should be “owned” and accepted by the management team as a whole and be seen to set challenging but achievable goals that they are committed to meeting. It should emphasise why you are convinced that the business will be successful and convey what is so unique about it.
Professional advisors can provide a vital role in critically reviewing the draft plan. Several of the larger accounting firms publish their own detailed booklets on how to prepare business plans. However, it is you who must write the plan as private equity firms generally prefer management driven plans.
The Business plan should cover the following elements:
***The market***
You need to convince the PE firm that there is a real commercial opportunity for the company and its products and services. This requires a careful analysis of the market potential for your products or services and how you plan to develop and penetrate the market. Information about the following elements should be provided:
► Market analysis
► Marketing plan
► Pricing
► Distribution channels
► Promotion
► Competition
***The product or service***
Explain the company’s product or service in a simple way. If the product or service is technically orientated this is essential, as it has to be readily understood by non-specialists. Emphasise the product or service’s competitive edge. For example, is it: A new product?; Available at a lower price?; Of higher quality?; Of greater durability?; Faster to operate?; Smaller in size?; Easier to maintain?; Offering additional support products or services? You need to convince the PE firm that the product or service is good.
***The management team***
PEs invest in people – people who have run or who are likely to run a successful business. Potential investors will look closely to the members of the management team. This section of the plan should introduce the management team and what its members bring to the business. Include their knowledge and experience, their drive, resilience and ambition and how they have learned from not so successful businesses. In this section it should be demonstrated that the company has the quality of management to be able to turn the business plan into reality. You need to convince the PE firm that the persons are fit to the job.
***Business operations***
This section of the business plan should explain how your business operates, including how the company produces the products or provide the services. It should also outline the company’s approach to research and development.
It should also include details on the location and size of the facilities. Factors such as the availability of labour, accessibility of materials, proximity to distribution channels, and the availability of Government grants and tax incentives should be mentioned. Describe the equipment used or planned and, if more equipment is required in response to production demands, include plans for financing it.
These and any other operational factors that might be important to the investor should be included.
***Financial projections***
Developing a detailed set of financial projections will help to demonstrate to the investor that you have properly thought out the financial implications of your company’s growth plans. PEs will use these projections to determine if:
► The company offers enough growth potential to deliver the type of return on investment that the investor is seeking.
► The projections are realistic enough to give the company a reasonable chance of attaining them.
Investors will expect to see a full set of cohesive financial statements – including a balance sheet, income statement and cash-flow statement, for a period of three to five years. Ensure that these are easy to update and adjust. Do include notes that explain the major assumptions used to develop the revenue and expense items and explain the research you have undertaken to support these assumptions.
***Amount and use of finance required and exit opportunities***
In this section of the business plan you need to state how much finance is required by your business and from what sources (i.e. management, private equity firm, banks and others) and explain for what it will be used (i.e. fixed assets, working capital, etc).
Finally include the consideration how the PE investors will make a return, i.e. realise their investment. This may only need outlining if you are considering floating your company on a stock exchange within the next few years. However, it is important that the options are considered and discussed with your investors.
How the PE investment process then takes place?
The investment process, from reviewing the business plan to actually investing in a proposition, can take a Private Equity firm up to one year but typically it takes between three and six months. There are always exceptions to the rule and deals can be done in extremely short time frames. Much depends on the quality of information provided and made available to the Private Equity firm. Bellow it is presented the main stages of the PE investment process.
After the agreement is signed and the funds have been transferred, you’ll start working with the private equity firm. Normally PEs will have an active approach aiming to add value to your company. In addition to advising on strategy, including in such areas as entering new markets, acquisitions and hiring new management, the PE will have many useful business connections to share with you, possibly including introductions to potential customers, suppliers, headhunters, acquisition targets and even to other PE firms in connection with syndicating financing rounds.
The PE usually aims to be your partner, someone to be approached for helpful ideas and discussion. Backing from a PE can provide credibility and status in dealing with third parties. However, day-to-day operational control is rarely wanted. In order to provide this support, some PEs will expect to have a seat on your board. The director may be an executive from the PE or an external consultant and fees will need to be paid for the director’s services.
Additionally, to be able to oversight the evolution of your company, the PE will expect to:
► Receive copies of your management accounts, promptly after each month end.
► Receive copies of the minutes of the board of directors’ meetings.
► Be consulted and involved in, and sometimes have the right to veto, any important decisions affecting the company’s business. This will include major capital purchases, changes in strategic direction, business acquisitions and disposals, appointment of directors and auditors, obtaining additional borrowings, etc.
How the PE will realize its investment?
Many shareholders are looking at some point to sell their investment or seek a stock market listing in order to realise a capital gain. PE firms usually also require an exit route in order to realise a return on their investments. The time frame from investment to exit can be as little as two years or as much as ten or more years. At the time of exit, the private equity firm may not sell all the shares it holds. In the case of an IPO, private PEs are likely to continue to hold the newly quoted shares for a year or more. The main exit options are listed below:
► Trade sale – The sale of your company’s shares to another company, perhaps in the same industry sector.
► Repurchase – The repurchase of the private equity investors’ shares by the company and/or its management.
► Secondary Purchase – The purchase of the private equity investors’ or others’ shareholdings by another investment institution.
► Flotation – To obtain a quotation or IPO on a stock exchange. In this exit option, is worth mentioning that the company, upon the PE investment may be better prepared given the reporting systems and discipline will be already implemented in the company.
