Make private equity a partner to give your business its best footing
2nd Apr 13
Small businesses face many challenges, not least of which is having the finance to achieve their potential and realise their founders' vision.
The banks are not renowned for their enthusiasm for small, relatively high-risk businesses. The founders' capital (and ability to mortgage their home) has its limits, so where do they turn? Well, for many small businesses with strong growth potential, the answer may well be to turn to private equity funds.
PE fund managers in Australia regularly invest in high-growth-potential smaller businesses. Indeed, despite the media's obsession with the big brand name PE deals, in Australia more than half of PE investments are into small and medium enterprises valued at under $50 million. A subset of these are owners wanting to expand their companies without giving up all their equity. PE investment can allow businesses to expand more rapidly than their working capital would otherwise allow and to take advantages of opportunities such as acquisitions to enable growth.
Growth or "expansion" PE funds make up more than 60 per cent of the local PE industry and represent a valuable source of capital for SMEs looking to further expand. As well as enabling this growth, PE managers bring many other benefits to the partnership with entrepreneurs. In this growth segment, the founders usually retain a substantial and sometimes majority shareholding. The PE investors bring expertise, networks and transaction experience to strengthen the company. They are there to help grow the company. If agreed progress is made, then additional tranches of finance to enable the ongoing growth will be made available. And with a sizeable portfolio of investee companies, when additional finance is needed, they have the clout to negotiate better deals with the banks. PE managers make money for their investors (generally super funds and other pension funds) by increasing the underlying value in their investments. Again, contrary to the myths about PE, you don't make money by slashing and burning an investee company. You make it by increasing the underlying value so that an acquirer will see real value in the company. During the three years to June 2011, even in the immediate aftermath of the global financial crisis, PE exits as a whole generated $5.7 billion in proceeds for their investors from the original $3.7bn invested. In the same period, the S&P/ASX 300 Accumulation Index showed an annualised return of just 0.26 per cent. The areas in which the PE fund is involved in assisting management fall into three broad categories: strategic thinking, financial aspects and operational management. They bring an experienced board of directors who can help with setting, critiquing and monitoring strategy as well as the relationships needed to achieve the company's goals. They bring financial expertise, structure and capital. And they bring operational expertise, access to additional executives, public company standards of reporting and good governance practices to give a company the best foundation to execute its strategy.
One of the most powerful roles the fund manager fills, from what chief executives in PE portfolio have said, is a sounding board for someone whose interests are aligned with management's but who isn't working in the business directly. Many CEOs relate stories of speaking at least weekly or more often with their PE colleagues to sound them out about ideas and generally feel less alone at the helm. So PE investment can be a boon to rapidly growing SMEs to help the founders realise their vision.