Financing for Your Growing Business

GROWTH CAPITAL

by Terry Stidham

You just left another meeting with another bank for financing and they told you once again that if you did not need the money they would be glad to make you a loan. Somewhat of a catch 22 for the business owner and the banker whose hands are tied by strict debt-to-equity ratios. The frustration is obvious, yet the solution may be just around the corner with Private Equity (“PE”) funding.

Private Equity Financing can be somewhat of a mystery for many successful companies facing financing challenges, but can be a highly effective source of funds. Many business owners assume that it is only available for the largest companies that are looking to be acquired. This misconception arises from the industry’s history: private equity grew out of the leverage buyout firms that purchased and broke up major conglomerates in high profile deals during the 1980s. The assumption was that the individual businesses were worth more than the sum. Other people only know the venture capital part of the industry, which funds startup companies and received a lot of attention during the high tech boom. Neither picture is complete.

Today, Gordon Gecko’s mantra of “greed is good” is long gone and the .com boom has busted, yet the PE industry is alive and well. The complex industry gathers private and institutional money in funds with a range of objectives. They include:

• Buyout Funds
• Hedge Funds
• Venture Funds
• Growth Capital Funds
• Dedicated Capital from High Net Worth Individuals

Private equity firms place its money in one or more funds to make investments in what are referred to as “portfolio companies.” They typically have a charter which sets out well-defined parameters for investments to be made by the fund, including:

• Nature of Investments - Some funds like high-growth companies, others prefer investments with stable cash flow or dividends. Still others prefer turn-around situations.
• Geographic Scope - Some funds will primarily invest in a certain region or part of the country.
• Preferred Sectors - Some funds are generalist funds that will look at just about any sector, others focus on one particular sector, such as transportation, infrastructure, telecommunications, etc.
• Investment Size - Most funds will specify a minimum or maximum investment size.
• Ownership Interest - Some funds insist on control, others will take minority interests.
• Fresh Equity - Many financial investors are not willing to buy out shareholders, they only want to inject fresh equity into a company (e.g. to fund growth). Others will consider a combination of fresh equity and buying out existing shareholders. Buyout funds will want to buy 100% of a company.

PE firms provide capital in return for an ownership stake. They usually invest cash in exchange for convertible preferred shares in the portfolio company. While many firms focus on larger businesses seeking $50 million or more in funding, there are a number of PE firms that work with growing businesses valued at $5 to $50 million and are seeking as little as $2 million in funding. The funding can take many forms ranging from common stock to convertible debt, but unlike traditional funding sources, the PE firm becomes actively involved in the companies it funds through board representation and active mentoring.

 

It is therefore important to find a good match between a PE fund and a company. It is likely a waste of time to enter into discussions with a fund if the applicant company does not fit the fund’s criteria. So what does a private equity firm look for in its investment choices?

• A Solid Business Opportunity - that reflects its acquisition criteria (e.g. growth, size, geographic parameters, etc.)
• Exit strategy – who are the likely buyers for the company? What are the chances for a successful exit?
• A Strong Management Team - who is prepared to stay until the exit of the fund. (An owner-manager who is cashing out is often too high a risk for the private equity investor.
• Strong Corporate Governance – good decision structures, reporting systems, and strong documentation. Private equity investors seek management teams that are highly motivated, prepared to agree to ambitious goals and prepared to work extraordinarily hard to achieve significant financial gains. Conversely, if results are not forthcoming, managers that own shares may find their ownership diluted.
• Manageable Risks - No actual, pending or potential litigation. Minimal potential for surprises on the downside.

 

After the due diligence, the investment committee (or at least certain members) will usually review the due diligence report of lawyers and other advisors, and the proposed Sale and Purchase agreement. 

 

PE investors are an important potential source of financing for mid-sized firms that needs to be explored.

 

If you have a business that is seeking financing then contact us today to discuss what is needed to get in front of the right PE group for your business.

 

About the author: Terry Stidham is a Sales and Business Development Leader with extensive knowledge of the M&A process, combined with an in-depth understanding of the constantly changing global capital markets environment. He has served as the head of entrepreneurial organizations as well as Fortune 500 companies. He specializes with mid-market companies in a diverse array of industry sectors from service and manufacturing to technical and professional firms.

Mr. Stidham speaks the language of both the seller and the buyer having vast experience on both sides of the transaction. He has been directly involved in the execution and successful closing of hundreds of investment banking and corporate finance transactions. Mr. Stidham has instructed thousands of business owners on how to prepare for a successful exit. He improves operational efficiencies leading to significant increased value.