Private Equity Timing:
The Multi-Million-Dollar Question
When should PE be considered? Many companies seek PE after hitting a brick wall with traditional debt financing and exhausting personal avenues. Waiting until this critical moment hurts the enterprise value and reduces your chance of raising the needed equity.
Yet PE firms offer more than funding. For example, they can provide strategic input on your business plan and growth strategies. They can help build the strength of your management team. And they can offer board expertise. For these reasons, and so many more, they are best approached at times when you are considering substantial expansion plans, or facing a critical juncture in the growth of your firm.
Failing to Plan Is Planning to Fail
Many companies with the potential to be excellent fail due to a lack of capital. While CEOs may embrace the business school mantra that “cash is king,” often they overlook their long-term capital needs.
Some business owners fail to plan far enough ahead and raise equity early enough to ensure successful and smooth growth. Raising equity is usually more difficult and expensive when owners wait until they really need the money. Others struggle by “boot strapping;” only reinvesting the cash flow generated from existing business. While they don’t have to sell a piece of their company, in many cases, they limit or may even preclude the company from growing into important markets simply because they don’t have enough resources.
You can avoid both of these traps by using PE to handle your capital needs-without taxing your cash flow.
They Companies That PE Companies Are Looking For
PE firms seek good companies that have the potential to be excellent— companies with a strong management team and a successful product or service that is operating in a market that offers significant growth potential. More than anything, they look for a company that needs funding to leap to the next level.
Assuming a company has significant growth opportunities, a PE will fund a variety of transactions, including:
- Buying a Competitor
- Buying Out a Partner and Expanding Management
- Expanding into New Markets
- Taking a Regional Company National
The bottom line for investors is that they seek risk-adjusted returns, and are willing to invest their money and know-how to make it happen. The bottom line for a business owner is that PE allows you to implement well thought-out growth plans.
What You Can Expect From a PE Firm
Companies that have not worked with a PE firm before will find the process very different than applying for a loan. They’ll need to refine their business plan to outline the planned growth and ensure all legal “i”s are dotted and financial “t”s are crossed before beginning the process.
More important, the CEO must cede some control—PE firms usually take a 40-65% stake—yet understand that he or she will retain day-to-day control and will likely end up wealthier than if the company grows using only its own resources and debt. Even Bill Gates ceded ownership control in return for growth potential.
The PE firm will propose a funding structure based on its valuation of the company. But beyond numbers, the two parties need to ensure that the chemistry is right, since the relationship is likely to last for years, if not the lifetime of the company. Both parties need to work together well, respect each other’s business vision, and build the right team for the company’s next period of growth.
PE does not replace a company’s banking relationship, it works with it. After an injection of equity capital, companies have even more avenues for growth, as the extra equity lowers the debt-to-equity ratio and opens the doors for additional borrowing.
If you are the owner of a growing company, PE can hold the key to taking your firm to the level that you can only dream of alone.