This blog comes from Chapter 1 of the eBook, in which Gareth answers the following questions:
- What is private equity and how does it work?
- What type of business opportunities does private equity look for?
- As a business owner, how can I benefit from private equity?
- As a private equity investor, what affects your appetite to invest?
- As a business owner, how do I become private equity ready?
- Where do I go for more information?
For a summarised version of Gareth's insights, take a look at our other resources:
- 'How to make your business private equity ready' cheat sheet
- 'How to partner with private equity' infographic
Comments by Gareth Banks, CHAMP Ventures
What is private equity?
Private equity is a partner, enabler, supporter or contributor to small and private businesses.
Private equity is much more than just some capital. You can get capital from plenty of places, but private equity is an aligned partner, helping a business to grow, set strategy and problem-solve.
How does it work?
The money for private equity investments comes predominantly from industry superannuation funds, both Australian and overseas, investment houses and sovereign wealth funds.
There are a range of private equity firms servicing different segments of the market. Some firms target equity investments of $5 to $20 million, CHAMP Ventures mainly invests $20 to $80 million, while others target $100 million plus.
What type of business opportunities does private equity look for?
There are two main styles:
- A traditional management buy-out sees private equity firms partner with management teams of a business and buy a business or division from a larger company, or other shareholders. Private equity is usually an 80-90% shareholder in this style.
- Private equity can be invested as a minority stake to help a founder diversify their assets or wealth, to help a passive shareholder in the business exit, or to provide money to help a business expand. In that instance private equity may be a 30, 40 or 50% shareholder.
What does private equity require?
Our basic requirements are:
- Management to back: As a rule we want proven executives to partner with, so management is a key requirement. We can help problem solve, think through strategy and bring complementary skills, but we’re not going to run the business day to day.
- A desire to grow and at least a basic strategy for that growth: In some cases people have thought that through in detail and our role is to stress test and critique it. In other cases the CEO has a skeleton vision and wants help working it up. We need to buy into a business, help grow its earnings and then sell it, or our share, in four or five years’ time – that’s how we make money.
As a business owner, how can I benefit from the involvement of private equity?
A lot of our opportunities are coming from providing a solution to an ownership transition, or management succession.
We can help a business owner who is looking for someone with complementary skills to help them on that journey.
Here’s a typical scenario:
A business’s founder owns 100%, has many of the key relationships with customers or suppliers, and he/she is finding it difficult to sell 100% of the business because they’re seen as integral to that business.
We can buy a stake from them, maybe 40 or 50%. They diversify their wealth and then we’ll be a partner with them for four or five years and help them recruit a CEO to replace them – maybe the founder can step up to be the Executive Chairman.
We can help them develop systems and begin to corporatise their business so it develops from a one-man family business and over a period of four or five years becomes a small corporate with some management. It’s then a sellable business.
Another way we can help business owners is if they’re looking for capital to expand or there is an acquisition they want to make, but they don’t want to put more of their own money into the business, or over-gear it. Our involvement will help a business owner achieve these aims.
Having said that, private equity isn’t for everyone.
If they want to hand the business down to their kids, then we’re not the right partner. We need an exit event over the medium term to realise value added for risk taken.
As a private equity investor, what affects your appetite to invest?
- People to back – We’re looking for a CEO or management that we feel comfortable working with and who will run the day-to-day operations. Often we have to help supplement the finance function, because it hasn’t kept up with the vision and growth. We help put in place a more robust finance function and maybe a chief financial officer, because you can’t grow without the right information.
- Alignment – All the shareholders and management need to be aligned on a goal or journey. If you don’t have alignment, your appetite to invest is gone. You don’t want one shareholder with a 20-year horizon and one with an 18-month horizon.
- Growth – It’s good to be in a segment that is growing, but it’s not essential as long as the business has a plan or sees an opportunity to grow itself.
- Point of difference – Do they have a point of difference and can they defend their position? If they’re one of many players who are all competing on price, then that’s a harder way to grow a business.
- Diversification of both customer and supplier – Often we see businesses where one customer is 60% of the revenue. This isn’t a deal breaker, but it is viewed a bit negatively.
As a business owner, how do I become 'private equity investment ready'?
Often, we come in and businesses are a little ‘green’ and haven’t thought through all the issues.
It’s useful to talk to someone, such as a business advisor or accountant, to brainstorm your ideas. I don’t need people to provide pages of information and glossy charts, but it’s good if they’ve already bounced around their ideas with someone.
It’s also very useful to talk to founders or CEOs who have partnered with private equity in the past, to really understand the process.
Business owners also need to understand their sense of scale and which private equity firms best match their requirements.
While it’s good for me if people have already thought about these things, I don’t mind if the initial meeting is a bit exploratory. That’s part of the education process and not every business is right for private equity, or ready.
Sometimes we’ll have a chat, agree a business isn’t ready and then we’ll get a call from the owner three years later when they are ready.
Where to go for more information
The Australian Investment Council (AIC) website is a good starting point: https://www.aic.co/AIC/Investment
The AIC (formerly the Australian Private Equity and Venture Capital Association Limited – AVCAL) is a national association representing the private equity and venture capital industries and the website provides plenty of information about private equity and venture capital.
And, of course, you can always talk to your business advisor.
If you would like advice or support regarding partnering with private equity investors, contact the team at JPAbusiness on 02 6360 0360 or 02 9893 1803 for a confidential, initial discussion.
James Price has over 30 years' experience in providing strategic, commercial and financial advice to Australian and international business clients. James' blogs provide business advice for aspiring and current small to mid-sized business owners, operators and managers.