Managing finances: private equity investment

Private equity has barely been out of the news over recent weeks. On a daily basis investment houses are being linked to rumoured buyouts of a host of high street names and established brands.

The media attention these deals command perpetuates a common misconception that this form of finance is only involved in funding mega deals, involving big listed firms.

However, beyond the mega deals there is a vibrant PE community making smaller investments and backing the growth aspirations of owner-managed businesses.
Whether it is a management buyout, an acquisition or a development capital deal, more firms are looking at PE as a means of bringing on board investors that can provide much more than just the funding required to expand.

Strategic strengths

PE can bring a number of benefits over other forms of finance. First, a relationship-focused PE partner adds value to a business by providing strategic operational and financial strength to the team.

Generalist investors bring to bear experience gleaned from activity across a range of sectors. This can help an owner-manager build on their growth strategy and put in place quality reporting structures and performance indicators that improve corporate governance.

PE investment also gives the business the support of a partner with significant financial reach. The ability to provide additional funding allows many businesses to quickly capitalise on acquisitions or new market opportunities.

A well-networked partner can also play a key role in identifying potential buyers. Crucially, a PE house can help prepare and position a business so that it has maximum appeal to a specific pool of potential buyers.

Private equity is held to be synonymous with buyouts, but there is an increasing trend towards owner-managers considering the option of development capital deals with investors. While it means relinquishing some equity, the value that it will create ensures that they ultimately have a significant percentage of a much bigger, higher-value organisation.

The reason for the growing popularity of the development capital deal is that it provides a number of clear benefits to business owners. These transactions provide the investment capital required to support new projects such as product development or entering new growth markets. They also allow private shareholders to de-risk part of their investment, often realising sufficient capital to ensure a degree of financial security going forward or to diversify their investment portfolio.

This form of funding also provides the opportunity for the owner to incentivise second-tier management by allowing them to acquire equity stakes in the business. This can be of great long-term benefit to the business in terms of succession planning. Crucially, it allows the owner manager to remain in charge, to be actively involved in managing the business and responsible for driving further value growth.

Set the bait

Raising private equity at the smaller end of the market has historically proven quite difficult. Some businesses rely on wealthy individuals or business angels. Others have realised on state-funded investment vehicles designed to stimulate economic growth in the regions.

If the business is looking for more than £2m of funding, the number of opportunities increases significantly due to the broad range of equity houses willing to fund this level of investment. When seeking an investor it is crucial that management and their advisers consider who they would want to work in partnership with. An investment won’t be a success if the PE investor is trying to be too hands-on, for instance. It’s about providing the capital and strategic support for management teams to deliver their plans, not micro-managing the business’s growth.

It is crucial management can see a long-term relationship with the investor. Understanding of the business and the dynamics of their marketplace needs to be coupled with a manager’s perspective and ability to work with their team to help create shareholder value in that business.

Case study

Having worked hard to create significant shareholder value, the management of software company Software Solution Partners were keen to realise some of their capital.

Its business advisers recommended a development capital deal with a private equity firm.

LDC took a minority stake in the company and within six months had invested to support the acquisition of a complementary business. The synergies and cross-selling opportunities helped the enlarged company to increase pre tax profits.
LDC also helped to develop the business’ systems and processes ahead of a potential AIM listing.

Upon its admission to AIM, LDC sold its shareholding in Software Solution Partners, leaving the management in charge of a larger, listed business.

Rob Pendleton is marketing director for LDC, the PE division of Lloyds TSB

For more go to www.bvca.co.uk