Private Equity Demystified

How does a PE deal work?

PE deals can take an almost infinite variety of forms with each having a unique structure, targets and incentives. The key is to understand that the PE deal will set a benchmark for returns on investment for investors. The management team will share in equity and value that is achieved above and beyond that benchmark. Failing to achieve the expectations of investors can lead to them becoming more active in the running of the business and making, sometimes drastic, changes to the management team.

Again, you should ask your advisor to help you understand the right kind of PE deal for you and your business.

What can I do to prepare for PE?

If you do just one thing to prepare for a PE investment, make it defining your vision of success. What do you want to achieve for yourself and for your business? Is success about a monetary value or about what happens to your business and the people who work for you? This ‘definition of success’ will underpin all the important decisions and choices you, and other stakeholders, will need to consider as you make your move to becoming a PE-backed business.

You will also need to prepare your business for PE investment. PE investment usually leads to substantial change to most aspects of a business as investors look to secure value growth and ultimately high levels of return on investment. You will want to prepare for due diligence by looking at a due diligence questionnaire to better understand the reporting requirements that you will have to meet. You should also check that your tax and financial structures are as efficient as possible.

What is the “equity story” or investment hypothesis?

Your equity story is the explanation of how your business will use PE investment to achieve value growth and the kind of return on investment that potential PE investor are looking for. The equity story is the foundation stone of any relationship with an investor.

It will include an explanation of the opportunities for growth, how these will be achieved and who the potential buyers of the business might be when it comes to realising the gains the business has made.

Our experience is that maintaining alignment of both investors and management around the equity story is one the most important keys to achieving success through PE.

What is the “Debt story”?

Accompanying your equity story, you should also consider the debt capacity of your business, your ‘debt story’. If your business is able to take on much cheaper debt, your blended cost of capital can be reduced. This, in turn, makes it easier to grow the equity value.

The health warning here is that over-gearing your business is a sure-fire way of destroying value.

What if PE isn’t right for my business?

PE is not the only option for funding growth. There are other options with their own advantages and drawbacks. These can include loans, venture capital, public markets, IPO, retained earnings and even friends and family. These may be better suited to your business strategy and goals. Your business advisor should carefully consider all the options and be able to help you find the right funding for your business.