Governments are running out of money. There is no magic money tree, and it is obvious that soon the support that has been provided to prop up struggling businesses during the Covid-19 pandemic will start to taper away. Businesses that have been, perhaps unfairly, sucking up capital, including human capital, are going to start to come under increasing pressure to stand on their own two feet.
As businesses start to fail, the companies that have managed to thrive during lockdown are going to become increasingly easy to identify. Those that have ruthlessly honed what differentiates themselves in the segment of market within which they operate, and the companies with strong leadership teams, are going to be well placed to capitalise on the disruption of the past year.
Is private equity investment the answer?
Managers of companies that have managed to thrive during the pandemic may be considering the best way to continue the growth of their businesses in the post-pandemic era. What are the best sources of capital to assist companies on their journey to recover? Well, traditionally a company seeking to raise more money can do this via debt or equity financing. That said, in the current economic environment, while debt financing might be cheap, it might also be difficult to obtain. So, what are the advantages of obtaining capital via private equity investment?
Interestingly, partnering with the correct private equity house can reap dividends by helping to raise cheaper debt. With the correct shareholders you will potentially be able to leverage the equity injected into the company, as banks are often more prepared to lend money to companies where they can identify factors that will mitigate their risk. The increased professionalism, and access to other financial resources, that accompanies a private equity investment is likely to give the banks a greater desire to lend money to the company.
Apart from increasing the sources of funds available for growth, how else can private equity help? One potential positive already alluded to is increased professionalism. Private equity investors have a good grasp of what can, and often needs, to be improved to drive growth. Having invested in numerous companies, they are aware of what can go wrong, and are mindful of the steps that need to be taken to improve the prospects of a company. This wealth of experience is an important resource to be drawn from, although both parties need to be respectful of the other’s expertise. Indeed, the best partnerships are those where the private equity partner is hands-off with respect to the technical side of operations, where it is likely the company has a better grasp of what the correct strategy might be, and hands-on when it comes to the more strategic vision of what the company should be doing on a macro scale.
The importance of the exit plan
Further to the above, what is key for any company that is considering inviting a private equity investor on board is an appreciation that the interests of the parties need to be aligned for the project to be successful. There needs to be clarity that ultimately the plan is that there will be some form of exit. The private equity investor may be giving you money to grow the value of the company, but that growth in value does need to be crystallised. Setting expectations at the outset as to the pathway to exit will likely save headaches further down the road.
Finally, private equity, unlike venture capital, is mostly focused on businesses with a proven track record (so revenue positive) as well as a defined pathway to exit. As such, an important piece of advice for companies seeking private equity investment is to make sure your financial house is in order so you can demonstrate that track record. It is also important that you make sure your legal house is in order, so when a potential private equity investor is conducting due diligence on your company there are no hidden issues which, when surfaced, result in price chipping or a radical restructuring of any potential deal. Giving your potential partners comfort that nothing is going to derail the joint plans for growth and exit is vital.
In summary, for the right companies, private equity investment is a good way to drive growth by increasing financial and professional resources. What is key is allowing each party to focus on what they are good at and ensuring that there is an alignment of interests when it comes to the overarching business plan.
Home page image by Justin Tallis/AFP via Getty Images
Ragavan Arunachalam is a senior associate at law firm Collyer Bristow.