What is Private Equity Funding?

Gaining the capital, you need to expand your business can take time and effort. 

Private Equity Finance could be a way forward when you have exhausted traditional funding methods.

However, a PE-backed company’s dynamic, fast-paced operating environment can give business owners a unique opportunity to grow their businesses. Still, it’s not for the faint-hearted; you must ensure you are “Investment Ready”.

Managing a private equity-backed firm brings a unique set of opportunities and challenges for business owners. 

On the one hand, private equity (PE) owners provide freedom and generous compensation unmatched by publicly-held corporations. Conversely, PE investors’ focus on results and their limited tolerance for underperformance can result in a rapid turnover of management teams if the interests are not aligned.

What is Private Equity Funding?

Let’s start by identifying what Private Equity funding is and its intended use. In essence, Private Equity Finance is capital that is not listed on a public exchange. Private Equity Finance comprises funds and investors directly investing in private companies.

The Goals of Private Equity Firms

PE funds use investor capital to buy and enhance companies’ value, which can involve increasing the company’s growth and cutting costs. The goal is for the private-equity fund and its investors to to make money when an investment is divested. 

How Private Equity Firms work

To succeed in private equity, business owners must develop a transparent and collaborative relationship with PE owners, who are very hands-on and expect quick questions. 

The interaction between owners and company managers is most concentrated in the early months post-investment (when PE firms work closely with managers to implement strategic change, organisational redesign and processes to track performance) and later prepare for an exit.

PE-backed boards are typically leaner than publicly listed companies and have a significantly lower percentage of independent directors. 

The board’s number and composition reflect the company’s needs at different stages of the holding period, increasing in cases of struggling investments and decreasing with success.

Board members from the PE firm will come to their meetings well-prepared and informed. They will expect the same level of commitment from others, making board meetings highly efficient and focused and setting a more rigorous pace, especially compared to boards of Family businesses. They may include a NED – Non-Executive Director

 with specific expertise who will engage with their portfolio companies at a more granular operational level.

How do Private Equity Firms Structure Deals?

With a typical funding structure resulting in a leveraged balance sheet, life as a Private Equity (PE) backed business focuses on cash returns to ensure investor debt is serviced.

Understanding working capital pressures, liquidity,, and free cash flow is a priority focus that needs to extend up to the Board level; it’s not just the finance team’s domain or the credit control department. 

Where banking covenants are involved, this immersion in cash management is taken to a new level of importance; unless there are exceptional circumstances, tripping a banking covenant inevitably signals the CFO’s end.

Of equal importance to cash, returns are profit generation; reported EBITDA needs to be an accurate, consistent and robust metric. Most PE deals have some form of EBITDA multiple embedded in their valuation, so it’s imperative that this metric is accurately reported and stands up to scrutiny in an exit process. 

The importance of quarter-on-quarter (and often month-on-month) EBITDA growth over the investment period can also bring unique challenges to a PE-backed business. With a typical three to five-year investment horizon, it is not desirable for PE-backed firms to start making sizeable investments in the latter stages of the journey. This diminishes the ability to convert such assets into suitable EBITDA returns in the appropriate timescales.

In Summary

Business owners require a very different approach when they become a Private Equity backed business. 

Your private equity investor is responsible for investing other people’s money wisely. Their reputation rests upon trust. So, respecting their need for information on performance and explaining issues is essential and, of course, the right thing to do.