Private equity investment for small and medium sized companies

There has been something of an outcry in the media of late over the booming private equity industry. There is a growing perception that these companies are buying businesses, borrowing large amounts of cash at low interest rates, cutting costs, and plundering them for all the short term gain they can extract for themselves and their investors before selling on at a massive profit within a few years, leaving the business with few long term prospects. "Private equity equals asset stripping" has been the cry from many, including trade unions, who are most concerned about the resultant job losses.

They may well have a valid point according to a new study just published by the Work Foundation. Workers at private equity controlled companies were more likely to be worse off, whether or not they come under the new management. This is because wages grew more slowly at private equity controlled companies then in the rest of the private sector. Private equity companies where there had been a management buy-in (MBI) had jobs cut by an average of 18% over six years

Britain boasts the most active private equity market in Europe and even big players in the City are bemoaning the lack of transparency in the industry and the amount of debt imposed on acquisition targets. However, many are saying that private equity firms simply need to do a better job of explaining what they do. Often, companies are bought by private equity to introduce badly needed shakeouts, restructuring and new strategies. Many public companies lumber from quarter to quarter and private equity is stepping in for impotent shareholders to shake the board and management from their stupor.

The benefits of private equity are not just restricted to multi-million pound corporates - there are firms willing to invest in certain types of small and medium sized enterprises looking to expand. If you are looking to fund the expansion of your business or release personal wealth tied up in the company either through a complete exit or a partial sale, then private equity is an avenue that should be explored. Alternatively, you may be part of a management team looking to buy your business from its current owners. These are just some of the circumstances where private equity funding might be appropriate.


What is private equity?

The British Venture Capital Association defines private equity as medium to long-term finance provided in return for an equity stake in potentially high growth unquoted companies. Private equity companies raise their funds for investment by pooling money from external sources such as pension funds, insurance companies and other large investors, and typically borrow heavily to leverage their investments. Therefore, they are looking for high growth companies with the potential to generate significant returns for their original investment.


How does it differ from other sources of funding?

Unlike a bank loan, private equity funding is not secured on any assets and is not repaid by interest and capital repayment (although it is often provided in conjunction with this kind of debt). Instead, the firm gains an equity stake in the business which will become more valuable as the business grows. When the private equity firm exits the business (usually within two to five years), it will realise a substantial return on its investment. Exit is commonly through either a sale back to the management, a sale to another company/ investor or a flotation of the company. However, if the business fails, the private equity company risks losing its investment just as any other shareholder would.


Would my company be suitable?

Private equity companies are interested in entrepreneurial businesses - i.e. those with ambition to expand rapidly. They are not interested in "lifestyle" businesses where the main purpose of the business is to provide the owner with job satisfaction and a steady income. Other factors a private equity firm will consider when deciding whether to invest in a business include:

Is the business a market leader, or does it have a USP with the potential to become a market leader?

Does it have a strong management team with the relevant industry experience?

Are the business's systems robust?

Is the business cash-generative with a steady income stream? (Required to repay the bank debt involved in the deal)

Do the owners/ management have a well-designed and viable business plan?


How much do private equity firms invest?

In recent years, private equity firms have tended to move away from the higher risk investments in smaller companies, and the big names such as 3i, Permira and CVC now save their investment for a smaller number of big deals. When looking for private equity financing for a smaller company, the key is to target the firms out there who specialise in the size, stage of development and particular sector of your company. As a general rule, private equity firms are typically looking to invest upwards of £100k, although some regional or highly specialist firms will consider investing less than this, particularly if there may be further investment possibilities at a later stage. Alternatively, you may be better off looking for a different source of external financing, such as a business angel, public sector funding or a venture capital trust.


What is the next step?

If you think your business may be a suitable candidate for private equity funding, approach a financial adviser. The adviser acts as a first point of screening between you and private equity firms, and will be able to give you feedback on your business plan and direct you towards any funds that may be a good match for your company's situation. Don't attempt to contact funds directly - without the credibility of backing from a professional adviser, this is unlikely to meet with success. The adviser will also be aware of recent deal activity in your sector, and may know which funds are considering further deals.

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