What makes one private equity funder better than another?

Looking for private equity backing? With the current market providing such rich pickings there is all the more reason to be discerning and the question is: what makes one private equity funder better than another for a particular management team?

>The private equity market is currently suffering a mismatch between the volume of private equity funding and the number of good investment opportunities – there is a great deal of funding and far too few good quality investments. But one of the benefits of this position is that management teams with reasonable propositions have a real choice when it comes to picking their equity backers. The question is: what makes one private equity funder better than another for a particular management team?

To get into the happy position where a management team has a choice of funders, the basic proposition must be well thought through and well crafted. But assuming this to be the case, the decision on which backer to strike a deal with requires careful consideration. First, the management team will need to pick a private equity house that understands the sector that they are in, that has a track record of doing deals in the sector and has a grasp of the company’s selling proposition.

The next point to check is that the PE house does not have a major conflict of interest. If its portfolio of companies includes, for example, a major competitor, then the management team would clearly not feel too thrilled about opening their books to that PE house.

However, in some sectors – nursing homes or special needs educational centres, for example – a PE house might well hold several investments, since the nature of the business is cooperative rather than competitive, and knowledge gained in one business can help others. Similarly, most retail operations do not compete, since their sales proposition will be very specific to their operation. In such cases, multiple holdings are not likely to be a problem.

Next, check the extent of the PE house’s portfolio. If they have a rich track record and a well-stocked portfolio, they will also have access to a ready pool of experienced talent that could join the board and strengthen the management team.

Then there is the question of how much “added value” the PE house can bring with it. The management team will have plenty of experience at running their business as things currently stand. But the PE house will understand matters such as management succession planning and mergers and acquisitions, and they will have plenty of experience at growing companies to the next level.

In most instances, preparing for this next growth leap will require access to experienced executives. The management team could go out and try to recruit such executives themselves, of course. But that is hard work, and without the prospect of a substantial capital gain the company will not be able to recruit top executives. On the other hand, a good PE house can introduce the company to people who really know and understand that particular industry. These executives can help to drive the company to a second exit, or to a liquidity event (an IPO). This can mean the difference between success and failure for management teams.

It is important to realise that some PE houses can demonstrate a glittering record of growth among their portfolio of investments. They can show a management team case histories which demonstrate that the original founders made some money when the PE house came in, and made a great deal more when it exited three to five years later. These stories build confidence and are very motivating. Other PE houses may be very hands off in their approach and this may suit some entrepreneurs who feel they know their business best and who do not want help. The key is to pick the PE house that suits a particular management team’s style.

Remember, PE houses, by definition, are serial deal-doers, and if your business plan is acquisition orientated, they can put someone on the board with a deep understanding of the M&A process. Again, this can make the difference between success and failure.

Finally, never neglect the importance of personal chemistry. All companies have a culture. Some PE houses are very “touchy feely”, others are hyper aggressive. Some are formal, some are highly informal. This is a people business so pick people you get on with.

Article by Mark Brockway, a Director at Ernst & Young.

Nick Britton

Nick Britton

Nick was the Managing Editor for growthbusiness.co.uk when it was owned by Vitesse Media, before moving on to become Head of Investment Group and Editor at What Investment and thence to Head of Intermediary...

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Private Equity