Attracting Private Equity investment

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Any Private Equity house will openly admit that they only invest in a small proportion of the businesses that approach them for investment. Simply explained, this is down to Private Equity being approached by too many businesses that cannot demonstrate the necessary business attributes.

Here are the characteristics of companies that are essential in attracting investment from Private Equity.

High growth

Private Equity investors target compound annual returns on investment of 20-30% and will hope for even higher. To achieve this, businesses they invest in need effectively to double profits every three or so years. But for many firms for different reasons, this is unachievable. However, without a business being able to offer this level of imminent growth, time spent pursuing a Private Equity investment can be a lost cause from the outset.

Strong defensibility

Conversely, Private Equity investors seek reassurance that a business’s existing profits are unlikely to shrink. So genuine service differentiators, preferred supplier status (despite meaning lower margins) and barriers to entry are all attractive in proving resilience and visibility of earnings. Furthermore, the turbulence of recent commercial markets makes such defensive qualities even more valuable.

Star management

Private Equity looks very closely at the skills and capabilities of any management team they will be backing, both as individuals and as a group. In doing so it often has four criteria which have to be met by management teams at the highest possible standard:

  • Clear ability to lead, manage and inspire employees
  • Keen detailed understanding of customers and the evolving marketplace
  • Proven track record in delivering profits and cash
  • Fluency when talking about profitability, balance sheet and cash-flow

Incomplete or average-and-below quality management teams is one of the most frequent reasons for Private Equity dropping out of bidding processes. Without a star management team being in place, a Private Equity deal is unlikely to happen.

Minimum size

As a result of how the Private Equity market has evolved internationally, there is generally a lower appetite for businesses whose normalised profits before interest and taxation are less than £1m (below this level it is a more a case of finding early stage venture capital). It is at higher profit levels (ideally £2-6m or above) that Private Equity investors get really interested and where owners can attract better deals. Therefore, owners often benefit from growing profits to these levels before seeking interest from Private Equity.

Clear exit plan

Private Equity houses only ever make money when they eventually ‘exit’ from their investments at a higher price. An exit will usually come in the form of a trade sale or, less frequently, an IPO (initial public offering). Therefore, investing in the type of business that is already proven to be attractive to trade buyers and stock markets is important to Private Equity investors. Without visibility of an exit, an investment becomes either more risky or simply undesirable.

Even when these characteristics are present in a business, significant preparation has to be completed to demonstrate these to Private Equity (far more than when selling to a trade buyer). However if this preparation is undertaken and a business successfully attracts Private Equity interest, owners are often able to agree interesting deals that provide some cash up front combined with a retained stake in the business for themselves and their best employees.

Published in the Recruiter, 26th November 2008


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