Private Equity is a type of medium to long-term business finance designed to help more mature businesses grow.
This can often take the form of buy outs and buy-ins of established companies.
Household names such as Boots, Moonpig, Asda, and the AA have all been taken on investment from private equity in recent years.
In this article we’ll explore what Private Equity is, how it differs from other types of equity finance, and its various advantages and potential drawbacks.
Before you agree to take any type of finance, it’s a good idea to seek independent specialist advice to ensure the type of finance is right for you and your business.
What is private equity?
While giving up control of your business might sound scary, private equity could be a good option if you, as founder:
- need funding and expertise to take your business to the next stage of its growth
- feel you've taken the business as far as you can
- want to retire
A private equity firm will take a large or controlling stake in your business.
In return, the business receives cash and an expert steer to help it grow, while your previous shareholders may receive a cash settlement.
Private equity investments are commonly utilised to aid management buyouts and buy-ins in established companies, distinguishing them from venture capital that is usually allocated for funding start-ups and younger businesses.
The private equity model is often used as a catalyst for sustainable business growth.
This success stems from operational expertise, effective management, and crucially, the collaborative relationship between the private equity investor and the company's management team.
Private equity firms typically aim to hold their investments for a period of four to seven years.
After this period, they will seek to sell or 'exit' their stake, potentially through the stock market, to a corporate purchaser, or to another investor.
What is a Buyout?
Also known as an acquisition, the term buyout refers to the purchase of a majority stake in a company (often over 50%), effectively gaining control over its day-to-day operations.
There are different types of buyouts depending on who is making the purchase and how it's financed.
When the company's existing management is the buyer, the transaction is referred to as a management buyout.
On the other hand, when the acquisition is largely financed through borrowed funds, it's known as a leveraged buyout.
Buyouts are common occurrences in scenarios where a company is transitioning from being publicly traded to a privately owned business.
What’s the difference between Private Equity and Initial Public Offering (IPO)?
Unlike publicly traded companies, which can have thousands of shareholders as a result of an IPO, private equity managers collaborate closely with the company's management team to improve business operations.
This governance structure facilitates more direct communication between manager and investor, promoting continuous engagement.
This 'active ownership' model allows the private equity manager to work in tandem with the company's management team to amplify the business value.
This can encompass various operational areas ranging from revenue growth, efficiency improvements, cash generation, procurement, supply chain optimisation, marketing, sales enhancements, reporting upgrades to staffing development.
This strategy becomes self-sustaining and an integral part of the company, ensuring a commitment to value creation and growth continuation even after the private equity firm has sold its stake.
Read our guide to IPO.
What’s the difference between Private Equity and Venture Capital?
Venture capital primarily invests into companies in their initial stages, including the seed (conceptual) phase, start-up (within three years of establishment), and the early development stage.
In contrast, private equity is associated with management buyouts and buy-ins of more mature businesses.
Generally, venture capital funds are invested in businesses at an embryonic stage, when they typically have minimal profitability history and require substantial cash inflow.
On the other hand, private equity funds are directed towards more established companies with the objective of minimising inefficiencies and propelling business growth.
This is often achieved through margin enhancement and/or the identification of new revenue growth opportunities.
Read our guide to Venture Capital.
Who's involved in Private Equity?
You (the seller)
The current shareholders of the company who want to sell.
Private equity investors (the buyers)
They keep an eye on the market and approach businesses that suit their investment strategy.
Buy-side advisers
Intermediaries, such as investment banks, corporate finance advisers and boutique advisers.
They help the private equity investors complete due diligence on your company, shareholders, and other key areas the investors have specified.
Sell-side advisers
Intermediaries who help you present your company for sale to investors in a professional manner.
Lawyers
You, and the private equity investors, will each hire lawyers to check the sale/purchase is properly and correctly documented.
Debt providers
Private equity often triggers a change of ownership.
Debt providers will help the private equity investors to buy their stake in the business and any existing debt.
This is called a leveraged buy-out.
What does a Private Equity investor look for when deciding to invest in a business?
Private equity investors are primarily focused on value creation.
To achieve this, they seek out companies led by high quality management teams who have a plausible strategy for business expansion.
These investors are not short-term profit-seekers; instead, they commit to a long-term investment plan and partner with the company's leadership to enhance the firm's performance and strategic trajectory.
Their approach to value creation involves aligning incentives, refining business strategies, operational enhancements, and bolstering corporate governance.
By adopting a 'buy and build' mindset along with a structured approach to organisational governance, private equity investors demonstrate a level of agility and flexibility.
This ultimately increases the worth of their investments and ensures that this value can be cashed in at a later stage.
What are the benefits of Private Equity?
There are a number of potential benefits for a company to access private equity, including:
Large investments
Your business might be able to tens of millions of pounds to finance its growth.
Professional help
Investors use their expertise to support the company’s growth strategy.
Their motivation for doing this comes from the opportunity to increase the value of their shareholding.
Exit strategy
Private equity funds aim to implement a strategy from day one to make a business more attractive to buyers.
Typically, this can be over a five-year timeline.
Personal process
Usually, you, as the business owner, will be dealing with a team of two to five investors, making the process more personal.
What are the risks of Private Equity?
As with all types of finance, there are a number of potential drawbacks to taking on private equity finance:
Few guarantees of growth
You're giving away a significant share in your business in return for finance.
There's no guarantee that your business will grow and succeed as a result.
Quick exit
Private equity investors typically look to sell their shares within five years.
It’s important to have a strategy in place for when this happens.
Read our guide to preparing for investor exits.
How do I choose the right private equity deal?
Ask an expert: Tim Hames, director general at the British Private Equity and Venture Capital Association (BVCA)
Private equity firms look for a place they can make a return. If I had to offer businesses three tips, they would be the following:
Tip 1: It’s more of a sin to ask for too little money than it is to ask for too much
If you end up going back and asking for more, it looks unprofessional. Pitch high in the first place and the firm can always scale you back.
Tip 2: Find a partner that brings you more than money
Look for sector knowledge or expertise that your board members don’t already have. Sector knowledge will bring contacts and networks, while experts will be able to pre-empt issues concerning personnel and expansion.
Tip 3: Save time by understanding the difference between institutions before you speak to them
Understand how your business matches up to the person you’re speaking to. Make sure you understand what they’re looking for.
What do I need to consider before taking on Private Equity?
Like all finance types, there are a few things you need to consider before deciding whether or not private equity investment is right for your business:
Giving up part of the business
Private equity investors often demand a controlling stake in your business.
Controlling interests
Investors will expect board seats and even their choice of chairperson.
Medium-term solution
Private equity is not a long-term source of funding.
Firms will often sell their shares after the investment period (usually within five years) is over.
Wide-ranging change
Taking on Private Equity can involve substantial change to your business.
Your willingness to embrace changes to the way your business operates is fundamental to Private Equity involvement.
These changes could include things like your strategy, operations, and management.
How do I attract Private Equity investors?
Intermediaries such as lawyers, investment banks or advisers might approach you.
Sometimes, private equity firms go to the business directly.
You can also approach firms yourself too.
Seek independent finance advice from your accountant or financial adviser, or speak with other intermediaries.
The process can take up to a year.
