Demystifying Private Equity
Many business owners are aware of private equity as a potential source of growth funding, but the benefits can often be unclear or misunderstood, leading to skepticism when assessing whether outside investment is right for their business. Martin McLaren, Investment Director at Maven, provides an insight into how private equity works.
When determining the most suitable funding, it’s important to remember that there are numerous sources of financing available. This includes traditional bank lending, subordinated debt providers, vendor financing, as well as private equity (PE).
PE houses are forward looking, prioritising the business’ future prospects, in contrast with more traditional lenders who are primarily focused on security and historic trading. This enables businesses to capitalise on exciting expansion and growth opportunities, which would otherwise be impossible without a significant cash injection.
PE managers, such as Maven, have significant experience of helping high-growth, entrepreneurial businesses achieve their potential, by providing flexible finance which can be used to fund a range of corporate requirements; whether that be growth capital to help businesses progress to the next level or supporting an ambitious management team to buyout the company they have worked hard to build.
As well as the cash injection, managers bring insight and strategic guidance through board and operational engagement. It is this added value which sets private equity finance apart from other forms of capital. PE backed businesses have been shown to grow faster than businesses using other forms of finance due to the synergies achieved through capital investment and strategic input. Indeed, as part of their investment, a PE investor will typically appoint an experienced executive to the board and may also introduce a Non-executive Director and/or Chair, who will have knowledge in growing a similar business, most likely in the same sector. This is where the combination of shareholder and lender results in a closer and more supportive role than other forms of financing.
The return on investment to PE investors depends directly on the business’ performance. The better it performs, the greater the returns to all shareholders. Therefore, there is a mutual interest in the success of the company. PE investors are also business partners, sharing the risks and rewards of ownership. If business performance dips, investors are incentivised to work with you to improve it and return value to the business.
There is often a misconception that owners are relinquishing control of their business to an equity investor. At Maven, whilst we do take a stake, we back management teams to run the business and there is a mutual goal for all parties to increase shareholder value. Though management’s equity share of the business may be diluted to some extent, the clear investment objective is to increase value of the equity for all shareholders and management have the reassurance of knowing that they have a supportive investor backing their development plans and who will provide strategic and commercial expertise if it is required.
When seeking an equity investment, businesses should be mindful of the key aspects a PE manager will look for in a potential investee.
- PE firms invest in people – the integrity and capability of the management team is critical when assessing future growth potential. Investors will look closely at the business owner and the members of the senior management team.
- Detailed financial projections – the business plan and forecasts will be scrutinised to assess the realistic return on investment, as well as the relationship between the growth strategy and the amount of capital required.
- Relevant market analysis – the analysis should show the potential opportunity for a business’s products or services and how management plan to develop and grow market share.
- Accessibility of information - if a business’s products or services are highly specialised and/or use bespoke technology, descriptions must be in a clear and logical format for those without an intricate background knowledge of that field.
PE investors won’t expect every company to be the finished article from the outset. After all, professionalising a business, and equipping it for growth, is where investors can create real value. Instead they will look for a business with identifiable market potential and which is led by an excellent management team.