Saffery partners Jamie Cassell and Niraj Patel recently spoke with Philip Duquenoy (Partner, Key Capital Partners) and Dan Potts (CFO, The Green Recruitment Company) to talk everything private equity (PE) in a Q&A webinar.
The conversation covered many aspects including: the advantages of PE over debt financing, the steps required to get ready for a PE injection, and when to start engaging with advisors.
You can watch our webinar on ‘Private Equity and Mergers & Acquisition’, but we’ve distilled the key takeaways in our article below.
How to prepare for private equity investment
The transition from an owner-managed business to one operating with external shareholders can be quite stark, and it’s often best to put those changes in place before the transition occurs.
PE backers will typically insist on regular monthly updates of management information, turned around promptly, and with focus on both short and long term cashflow. Generally, this is information that management has access to already, so it is just a question of formalising and expediting those processes.
Expanding the management team to ensure you have all the required skills can be helpful, and in particular having a Finance Director in place to manage the transition enables other members of the team to remain focussed on core operations.
When to consider private equity
While the transition itself is typically triggered by the business’ need for capital, advance preparation for an expected PE injection can significantly smooth the process. Starting a couple of years in advance gives you a great chance to focus on getting all of the compliance processes in order without the pressure of an immediate deadline, whether that be cash forecasting, audits, contracts or data protection.
A good corporate finance adviser will often want to be involved from an early stage – even if that involves informal conversations while the business makes the required changes. In the year running up to an anticipated capital event, they can help to ensure processes are as efficient as possible, and test due diligence to identify issues in advance.
The most important thing to remember is that the PE investor is looking to buy into the future growth of the business, so while demonstrating the smooth running of the internal processes is key, you still need to remain focussed on the core operations and revenue growth.
Why is vendor due diligence important?
For larger transactions this is a fairly standard procedure; it can compress the timescales of an ultimate capital event and give any prospective investor an insight into the business. However, by its very nature, investors typically interpret it as being favourably slanted towards the vendor, and so some follow-up work is inevitable which can add to the costs of a transaction.
Often, a lighter touch approach can be more effective, such as a Seller Information Document. This is less of a deep dive, with a limited scope, but can be used to focus on the key financials and any areas identified as being of higher complexity. This enables investors to get a flavour of the business up front without having to wait for the full due diligence.
What are the key criteria for private equity investment?
Exactly what a particular PE firm will be looking for will vary according to the preferences of the individuals investing, and of course all businesses have their individual foibles, but there are certain universals that will help any entrepreneur looking for PE investment.
The first is a strong core management team. Any good PE house will be looking to have a long-term relationship with management to safeguard their investment, and so knowing that there is a team in place that they can work with is a significant selling point. It doesn’t necessarily need to have all the required skillsets in place up front, but they will want to know that the core team are committed and aligned to the same end goals as the investors.
Beyond this, investors need to have confidence that the business can deliver the expected growth. To that end, it needs to be able to demonstrate that there is sufficient market space to grow into – and that growth potential needs to extend beyond the lifetime of the expected PE investment to enable a future exit. If there is an intention to capitalise overseas, then some track record in this regard is helpful. Whatever the strategy is, it needs to be clear that a focussed plan is in place to deliver it.
Ultimately, the PE investors will consider the investment from the viewpoint of the exit plan and work backwards from there.
What are the advantages of private equity over debt financing?
The key advantage is the buy-in of an interested and experienced investor. When working with the right PE team, you should gain access to various skills and a network which is experienced in utilising investments to grow company value and in working towards an ultimate exit event.
While a bank will typically be focussed on quarterly covenants right from the beginning, a PE investor can be more open to taking a long-term view; and in particular will be used to up front investment in the operations, meaning that revenue growth is limited in the first year.
Of course, it is always possible to take both approaches; using PE investment for the strategic growth, while bank financing is used for operational needs. The presence of the PE backer can help in securing contracts, and in particular, may enable you to leverage further and subsequently scale up more rapidly.
If you are considering using a capital injection in the future to grow your business, or have any questions regarding any of the points raised here, then please speak to your usual Saffery contact, or get in touch with Luke Hanratty.