How to pursue private equity backing for acquisitive growth

With the UK economy struggling to recover from the effects on the population of the coronavirus pandemic and the on-again off-again lockdowns, it has been almost impossible for the majority of businesses to expand organically.

Early 2020 saw redundancies soar at the fastest pace and reach the highest level on record. Almost a third of the entire workforce was on the government-subsidised job protection scheme. And just as a recovery of sorts was dawning at the end of the year, a new strain of coronavirus plunged the country back into full lockdown.

One of the few viable ways for businesses to expand during the current crisis is through acquisitions. Acquiring businesses complementary to your own, providing you successfully integrate them, could put you in a strong position to benefit from a post-COVID economic resurgence.

The massive levels of uncertainty and distress plaguing many businesses mean that there are no shortage of acquisition targets, with many more open to a sale or available at a more favourable price than they would ordinarily be.

The likelihood is that your business may be feeling some of the strain of the pandemic too and, even if you aren’t in any imminent danger, you might not have the funds at your immediate disposal to go on an acquisition spree. With banks more focused on offering COVID-19 business emergency loans, this may also prove to be a more difficult way to source funding.

However, this doesn’t necessarily preclude you from building your business through acquisitions. Whilst there are a number of debt and equity funding avenues to explore - covered in some of our previous articles, today we are taking a closer look at private equity firms, which collectively have record levels of money to invest (or “dry powder”), with many having slowed or paused their activities during the pandemic.

If your business fits the profile private equity firms look for and can demonstrate the value it could deliver through an acquisitive growth model and, perhaps most importantly, if you can find a private equity firm that you feel you could build a mutually beneficial working relationship with, then private equity funding could be the perfect way for your business to hit the acquisition trail.

What do private equity firms look for?

It should be stated early on that private equity backing is not something that is going to be available to the majority of business owners. Private equity houses, on the whole, will have fairly stringent criteria for a business to meet before they will consider investing.

Here are some of the criteria that private equity firms might look for when investing in a business:

Financials:
Over £10m annual turnover
+ £2m EBITDA
Strong cash flow
Operating margins of at least 10 per cent
Gross margins of at least 20 per cent


Business:
Decent excess capacity in operations
Organic growth potential or clear acquisition strategy
Stable margins
Competitive advantage sustainable over the medium term
Strong recurring or repeat revenues
Good second tier management

While certain private equity companies may consider smaller businesses, they will likely be even more particular about the profile of the business they will invest in and will need to see clear evidence of growth potential, as well as a top drawer management team and evidence of corporate maturity.

If SME owners are seeking to grow through acquisitions, it would perhaps be more advisable to seek venture capital financing.

The types of investments private equity firms typically make range from straight or leveraged buyouts, minority stake acquisitions and public-to-private takeovers to flotations, refinancings or bolt-on acquisitions at firms within their existing portfolio.

A crucial element of any private equity deal is that they will more often than not be looking at making an exit from the business within 5-8 years. A private equity firm’s exit strategy is one of the core reasons why they will not ordinarily invest in a smaller business. When it comes time for them to exit the business, they are likely to be looking at selling on at a multiple of around 15-20x, more than double what a typical SME might achieve in a private trade sale.

Why should you seek private equity backing?

Getting the backing of a private equity firm to pursue acquisitions can be an excellent way for your business to rapidly expand, due to the scale of funds and strategic expertise that will be made available to you.

If you are able to attract backing from a private equity firm that trusts your judgement as the leader of your business and has the means and willingness to back your growth strategy, then you will be able to quickly and aggressively pursue acquisition opportunities.

Working with a private equity backer can also help you to avoid the scrutiny associated with pursuing more regulated forms of acquisition funding, such as business loans.

Private equity firms typically follow an ‘active ownership’ approach, whereby the PE firm works alongside company management to enhance the business value. The added financial backing and expertise should have a direct effect on the company’s profitability.

Working with a private equity firm will admittedly mean handing over a significant slice of the profits from your acquisitions, but their financial backing and expertise can mean that the profits you start bringing in could be significantly higher than what you’ve ordinarily seen.

Preparing to attract private equity funding

Potential backers will want to see that not only is your business successful, but that it is run smoothly and efficiently. Organised documentation, well-managed accounts, protected IP and sound processes will make a private equity firm’s due diligence process quicker and demonstrate a level of efficiency and professionalism in your business.

If you are raising money for acquisitions and your own business is not running efficiently, a private equity firm is unlikely to trust you to use their investment wisely.

Due diligence will be a crucial consideration for private equity firms and they will go over your business with a fine-tooth comb. Ensuring that they can get a quick, clear and accurate picture of your business will increase the likelihood of them investing and offer a solid foundation for your future working relationship.

Your acquisition strategy will be examined by the PE team and if you already have an acquisition target in your sights, the rationale for the purchase and financials of the deal will be closely analysed. If you are gunning to buy up distressed assets, it will be imperative to demonstrate your turnaround strategy is sound and without high risk.

It will also be important to have a solid management team in place that is experienced in your field and committed to the company and its plans for expansion.