Demystifying private equity

Price Bailey's Sarah Moores explains private equity, beyond the hype of Dragon's Den and the mysteries of Silicon Valley

What does “private equity” mean to you? It is a term that has become almost mainstream, but that doesn’t necessarily mean that we all understand what is actually is, and what it can offer growing owner managed businesses or SMEs.

In this article we try to demystify it and show you how it might be relevant to you and your business.

Private equity, or “PE”, is now a mainstream funding option. Most of the mid-market firms have raised new funds in the last 18 months, and they are actively seeking out new business opportunities.  And more of these funds than ever are finding their way to supporting transactions in the SME sector.

In February 2016, Tim Hames, director general of the British Private Equity and Venture Capital Association commented, “our best estimate is that more than 85pc of private equity and venture capital investment in the UK is now in the SME sector”.

Very broadly the types of deals private equity will support can be split into three types:

Development capital

100% of the investment remains in the business providing funds for a business to, for example, invest in R&D, development of a new site, overseas expansion, or an acquisition.  Often these types of transactions are funded by types of firms called Venture Capital Trusts or “VCTs”

Partial exit or shareholder restructure

This scenario could occur where some of the shareholders want to sell all or part of their stake, or perhaps a founder has all his or her wealth in the business but is not yet ready to sell all of the business but would like to take some cash out of the business.  PE can step in as a partner those remaining shareholders.

Management buyout (“MBO”)

In this case the owner is typically seeking to sell most or all of his business, with the management team remaining to take the business forward. PE can provide funds to support the existing management team to acquire the business. This is a good alternative to a trade sale where there is a strong management team in place who would like to retain the independence, and participate in the future as shareholders.

In either an MBO or a partial exit, the PE funds can provide additional capital for development, supporting the new management to make step changes in the business which may not have been possible under a previous owner.

So why would you consider a private equity partner for your business?  Let’s consider come of the benefits:

  • They are an excellent business partner – obviously they can provide financial support to the business as it grows, but they offer more than just cash, and can provide expertise range from recruitment to business development, to expertise in overseas expansion or integrating acquisitions.
  • They offer flexible deal structures – most PE firms are flexible with regard to deal structure, taking a majority or minority shareholding as appropriate. This allows them to offer a solution to a particular shareholder problem or challenges that may seem at first glance seem intractable.
  • They offer the management to participate in future success – most of the PE houses have a very strong ethos of “backing” a management team. They want the team to succeed, so that they succeed, and part of that is enabling management to participate in the business as shareholders.
  • They make it easier to raise bank debt – banks are comforted by the presence of a private equity investor and it can often make it easier to secure bank lending and services.  Don’t be scared off by the stories of PE houses loading a business with debt; the mid-market firms do not operate in that way, and will look to add a manageable amount of leverage to any deal.
  • Take the lead on exit strategy – a PE firm is not an investor forever, and they will look to sell the business on after perhaps 4 or 5 years. However, they will take the lead during this process, and will invest time and resources to work with the business on an exit strategy securing the best return possible for all shareholders, including management.

It goes without saying that it is important to have the right advisory team with you during a private equity deal, who have been there before and can guide you through the process. A good corporate finance advisor will help you present your business in the best way, as well as introducing you to the private equity houses that will best suit your requirements. Good legal advisors will help you navigate the various documents, which can be a little daunting at first, as well as negotiating on your behalf with the PE firm’s legal advisors.

I hope if nothing else this article has made you think about private equity in a different, hopefully more positive way.  Private equity might not be right for everyone, but you won’t know that unless you consider it.

Sarah Moores is a director at Price Bailey


Sarah Moores

Sarah Moores is the director of strategic corporate finance at Price Bailey.