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Selecting a private equity firm

HOW TO CHOOSE A PRIVATE EQUITY FIRM; CRITICAL CONSIDERATIONS IN SELECTING A PRIVATE EQUITY MANAGER

WHAT IS PRIVATE EQUITY?

Private Equity (PE) is another source of investment capital that invests in the equity capital of privately held companies, I.e. companies that are not publically traded.  Private Equity actually derives from high net worth individuals and institutional investors that acquire equity shares of privately held companies or acquire a controlling stake in publically traded companies to make them private, eventually becoming delisted from public stock exchanges. These companies are not listed or traded on any stock exchanges. The PE capital can be used to develop new products and technologies, expand working capital, make acquisitions, or strengthen a company’s balance sheet. Now private equity has gained a great amount of influence in today’s financial marketplace.

Sources of private equity

There is a wide range of types and styles of private equity available across the world. The primary sources are private equity firms that may provide finance at all investment stages and business angels that focus on the start-up and early stages. In targeting prospective sources of finance and business partners, as in any field, it works best if you know something about how they operate, their structure, and their preferences.

Read More: Top 10 private equity firms
Private equity firms

Private equity firms usually look to retain their investment for between three and seven years or more. They have a range of investment preferences and/or types of financing required. It is important that you only approach those private equity firms whose preferences match your requirements.

How do I select the right private equity firm?

As far as a company looking to raise private equity is concerned, only those whose investment preferences match your requirements should be approached. Private equity firms appreciate it when they are obviously targeted after careful consideration.

Targeting

The most effective way of raising private equity is to select just a few private equity firms to target with your business proposition. The key considerations should be to assess:

1. The stage of your company’s development or the type of private equity investment required.
2. The industry sector in which your business operates.
3. The amount of finance your company needs.
4. The geographical location of your business operations.

You should select only those private equity firms whose investment preferences match these attributes.

(1) Stage/type of investment

The terms that most private equity firms use to define the stage of a company’s development are determined by the purpose for which the financing is required.

(a) Seed Stage

To allow a business concept to be developed, perhaps involving the production of a business plan, prototypes and additional research, prior to bringing a product to market and commencing large-scale manufacturing. Only a few seed financings are undertaken each year by private equity firms. Many seed financings are too small and require too much hands-on support from the private equity firm to make them economically viable as investments. There are, however, some specialist private equity firms which are worth approaching, subject to the company meeting their other investment preferences. Business angel capital and incubator funding should also be considered, as with a business angel on a company’s board, it may be more attractive to private equity firms when later stage funds are required.

(b) Start-up

To develop the company’s products and fund their initial marketing. Companies may be in the process of being set up or may have been trading for a short time, but not have sold their product commercially. Although many start-ups are typically smaller companies, there is an increasing number of multimillion-pound start-ups.

(c) Other early stages

To initiate commercial manufacturing and sales in companies that have completed the product development stage, but may not yet be generating profits. This is a stage that has been attracting an increasing amount of private equity over the past few years.

(d) Expansion

To grow and expand an established company. For example, to finance increased production capacity, product development, marketing and provide additional working capital. Also known as “development” or “growth” capital.

(e) Management buy-out (MBO)

To enable the current operating management and investors to acquire or purchase a significant shareholding in the product line or business they manage. MBOs range from the acquisition of relatively small formerly family-owned businesses to well over £100 million in buy-outs. The amounts concerned tend to be larger than other types of financing, as they involve the acquisition of an entire business.

(f) Management buy-in (MBI)

To enable a manager or group of managers from outside a company to buy into it.

(g) Buy-in management buy-out (BIMBO)

To enable a company’s management to acquire the business they manage with the assistance of some incoming management.

(h) Institutional buy-out (IBO)

To enable a private equity firm to acquire a company, following which the incumbent and/or incoming management will be given or acquired a stake in the business. This is a relatively new term and is an increasingly used method of the buy-out. It is a method often preferred by vendors, as it reduces the number of parties with whom they have to negotiate.

(i) Secondary purchase

When a private equity firm acquires existing shares in a company from another private equity firm or from another shareholder or shareholders.

(j) Replacement equity

To allow existing non-private equity investors to buy back or redeem part of another investor’s shareholding.

(k) Rescue/turnaround

To finance a company in difficulties or to rescue it from receivership.

(l) Refinancing bank debt

To reduce a company’s level of gearing.

(m) Bridge financing

Short-term private equity funding is provided to a company generally planning to float within a year.

(2) Industry sector

Most private equity firms will consider investing in a range of industry sectors – if your requirements meet their other investment preferences. Some firms specialise in specific industry sectors, such as biotechnology, computer-related, cleantech and other technology areas. Others may actively avoid sectors such as property or film production.

(3) Amount of investment

The majority of private equity firms’ financings each year are for amounts of well over $1,000,000 per company. There are, however, a number of private equity firms that will consider investing amounts of private equity under $1,000,000 and these tend to include specialist and regionally orientated firms. Companies initially seeking smaller amounts of private equity are more attractive to private equity firms if there is an opportunity for further rounds of private equity investment later on. 

The process for investment is similar, whether the amount of capital required is $1,000,000 or $100 million or more, in terms of the amount of time and effort private equity firms have to spend in appraising the business proposal prior to investment. This makes the medium to larger-sized investments more attractive for private equity investment, as the total size of the return (rather than the percentage) is likely to be greater than for smaller investments, and should more easily cover the initial appraisal costs. Business angels are perhaps the largest source of smaller amounts of equity finance, often investing amounts ranging between $20,000 and $1,000,000 in early-stage and smaller expanding companies.

4. Geographical location

Several private equity firms have offices in major financial cities across the world. Some regions are better served by more local private equity firms than others, but there are also many firms, particularly in major towns targeting growth-oriented companies across the country.

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