Why would I sell a shareholding in my business to a private equity investor rather than seeking an IPO or selling to a trade buyer?
Whilst a public listing is an admirable goal, most (but not all) founder-owned businesses are not big enough to support a successful IPO. Businesses which are too small when listed end up becoming “zombie” companies which are unable to raise further capital as their shareholder base is not deep enough, difficult to be acquired by competitors due to takeover requirements, subject to significant additional costs of public listing and subject to disclosure requirements including shareholding and remuneration arrangements. Generally speaking, the threshold for an IPO that is viable in the long term is a minimum market capitalisation of $100m free float (ie. available to be traded and excluding shares retained by existing shareholders).
Regarding a sale to a trade acquirer, if the founder has a management team in place and is prepared to sell 100% of the business (possibly with a portion of the sale proceeds subject to an earn-out), this may deliver the highest sale price. However, many trade participants are seeking businesses with minimum EBITDA of $10m or revenue of $100m to make an acquisition worth their while, and the sale process can be very intrusive particularly if the trade acquirer is a competitor. Many smaller business owners look to bring a financial investor on as a partner in their business as part of the pathway to an eventual sale to a trade acquirer as the financial investor can assist with growth to the required scale and the steps required to make the business suitable for and attractive to a trade buyer whilst allowing the business owner to sell the business in two stages.
Why would I want a private equity investor involved in my business?
There are a few main reasons why a business owner might want a financial investor as a partner in their businesses:
- Financial investors can provide access to capital to fund growth initiatives, to provide some asset diversification (“cash off the table”) for the business owner or to reduce debt whilst enabling the business owner to maintain a significant (and sometimes majority) shareholding in the business. This effectively gives the owner “two bites at the cherry” at the sale, where if the growth plans are delivered, the second sale will be at a significantly higher value than the first
- Financial investors are partners who will work with the business to assist with growth and other improvement initiatives as well as the ultimate succession plans for the business owner
- If the business has bank debt as part of its capital structure, a financial investor can assist with the removal of personal guarantees and security over property
Once I receive an investment inflow, what are my options for how it is used?
Broadly speaking, inbound equity investment can be used to fund a diversification of the owner’s asset base, to fund growth opportunities, to reduce debt or a combination of the three. The use of the new equity investment would obviously need to be agreed between the existing shareholders of the business and the new equity investor well prior to the investment occurring. In certain circumstances, the introduction of a financial investor may also facilitate the removal of personal guarantees and security over the owner’s personal assets.
I’ve always been interested in expansion through acquisition rather than having restrained growth through reinvesting my cash flows, BUT doesn’t that mean I lose control of the business?
Not necessarily. Not all financial investors require a controlling interest in the business, with certain investors such as Axle preferring “partnership” style investments with the existing shareholders where each of the incoming and existing shareholders own 50% of the business with neither party controlling the other. Whilst an incoming equity investor will always want to have a level of influence over the business and vetoes over major strategic decisions, equity investors with experience in a partnership-style investing will fundamentally be backing the existing management team to continue the success of the business to date. The incoming investor will then look to add value in areas such as strategy, mergers and acquisitions, capital structure optimisation, assisting with building out HR capabilities, providing relevant introductions and ultimately maximising the value of the business upon exit.
Selecting the right equity partner whose values and goals are aligned with the existing shareholders and management of the business is critical.
What value can a private equity investor add to my business?
Financial investors generally have significant business experience through involvement with multiple businesses facing a range of opportunities and challenges. As such, financial investors are partners who will work with the business owner to deliver growth and other business improvement initiatives such as:
- Being a “sounding board” with an aligned interest with the business owner for decision-making
- Providing strategic assistance at the board level. Whilst financial investors will never know the business as well as the business owner, they can use the experience that they have gained from their other investee companies to assist with a variety of situations
- Identifying gaps in the business’ management team and assistance with recruiting suitable individuals to meet those needs
- Identification of and assistance with the execution of acquisitions
- Funding and assistance with strategic initiatives such as geographic expansion (both within Australia and internationally), new product/service development, technology investment, marketing initiatives
- Where appropriate, assistance with raising debt and/or improving lending terms, including the removal of personal guarantees or security over real property
Under what circumstances would a private equity investor not be suitable for my business?
If a business owner is looking for a passive investor who will have little to no involvement in the business rather than a partner to work with them on the growth of the business then a private equity investor would most likely not be suitable. Otherwise, there are financial investors who target a range of businesses from start-ups to much larger businesses and have experience in a broad range of sectors across the economy.