How do business owners find the right private equity partner?
Different private equity firms focus on different sorts of businesses although there are some common themes. While Australians often use the terms venture capital and private equity interchangeably, venture investors will usually look more at early stage businesses whereas private equity investors will usually look at more mature, established, businesses.
Private equity can help management teams to acquire businesses from founders through management buyouts (MBOs). The new capital structure can then help those businesses to grow organically or by acquisition. Examples include ACL (Australian Centre for Languages), Netti and Godfreys.
Divisions of larger businesses that are not core to the overall company’s strategy are also often suitable private equity targets. Repco, Accantia/Swisspers and John West are Australian examples. More recently, we are seeing that ‘undervalued’ public companies (such as Just Jeans, Flight Centre and Coles) can attract interest from private equity buyers.
Further, earlier stage venture capital investing can support companies with rapid growth needs such as technology companies (for example Comtech, Hitwise and Resmed).
So what do private equity firms look for?
Private equity firms’ investment criteria vary. However, most private equity firms look primarily for a team of proven, honest managers who have established a good record operating the actual (or similar) business and can align their interests with investors.
Industry stability and strong business cash flows are generally attractive and will often lead to a more leveraged capital structure. This combined with substantial growth potential can enable the investor to feel more comfortable with the price for the business. However, a reasonable entry price having regard to the above factors and the future exit prospects is always important. Finally, good private equity firms will also only select companies where both they and the management team agree that the private equity firm can provide strategic and financial assistance and counsel to the business to deliver on its strategy. This is difficult to measure and often comes down to the fit between the individual personalities.
So how does a business owner find the right private equity partner?
Given the importance of fit, there is no substitute for spending time with your potential private equity partner. This is a more important decision than choosing a service provider – the business is choosing a partner that will be very influential over future outcomes.
All stakeholders including management, vendors and financiers need to have confidence in the private equity firm to deliver on expectations. Criteria for choosing appropriate firms often include:
• Credibility, integrity and ability to maintain confidentiality;
• Ability to structure and fund the transaction;
• Transparent and speedy investment approval process;
• Complementary fit with management, including ability for the private equity firm to add strategic and financial value.
Understanding the investment criteria of each private equity firm can make this match making exercise more efficient. Credible firms generally make their market focus reasonably clear on websites and other publicly available information. For example, a firm such as Anacacia Capital cannot invest in start-ups. Other firms focus their efforts only on start-ups or early stage ventures.
When should a vendor consider approaching a private equity firm?
MBOs usually result from succession issues within private companies or from parent companies wishing to divest non-core assets.
Engaging an advisor to run a sales process involves inviting several trade buyers and financial investors to tender their interest. While such competitive tension can maximise the likely price, it may also risk sensitive information falling into competitors’ hands. If not run correctly, this may tarnish the business, particularly in the case of an aborted sale.
Alternatively, vendors may enable a private equity firm, either with existing or new management, to have a preliminary look at the business. If they can meet the vendor’s price expectations, they can then enter into exclusive arrangements to complete more detailed due diligence and documentation.
There are several advantages of a vendor approaching a private equity firm in the first instance, particularly where the following factors are important:
• Management may understand the potential business value better than other parties and will require less due diligence;
• The confidential process minimises the chance of damaging information leaks;
• There is flexibility to move later to an auction sales process if private equity does not proceed;
• They wish to reward loyal staff (particularly common in private businesses); and
• MBOs can often be more acceptable to other stakeholders including competition regulators, the broader workforce, customers and suppliers.
There are differences between private equity firms but there are probably more similarities. The basic investment criterion of backing proven management teams in businesses with strong potential is a repetitive theme.
Similarly, companies will generally be well advised to seek private equity partners that are willing to pay a ‘fair’ price and have the reputation and potential to help their businesses grow into the future. However, despite all the best quantitative analysis (and good private equity firms do a lot of this!), the end decisions often come down to personality fits and qualitative judgments about people’s honesty and capabilities.
Jeremy A. Samuel*
* Jeremy A. Samuel is managing director of Anacacia Capital and chairman of its investment committee. Anacacia Capital invests alongside proven management teams in established small-medium enterprises. This article is an introduction to a complex, dynamic area and is not intended to be a substitute for independent advice or to represent the extensive views, opinion or advice of the author or his employer.