Deal Structure
Terry Stidham
You need to know going in that there
will two important parts of the deal –
1.
Amount of capital financed
2.
Terms/ Conditions
Answer these key questions before seeking financing from PE:
·
How much do you need?
·
How will the capital be used?
·
How soon and over what time period?
·
In what form of equity are you willing to
structure?
·
What are you willing to give up in terms of
control?
All private equity (PE) deals
employ equity in some form, but the actual deal may use one or more instruments
ranging from common stock to convertible debt. Investments may be made up front
or over a period of months or even years.
The PE investor will assess
your funding needs and propose a funding structure. The final structure will be
determined through discussions of how a business relationship can be built that
meets your company’s funding needs and the PE firm’s need to ensure the success
of your business, and their investment.
The Issue of Control is a key consideration one must make when using
financing from PE. Business owners who have devoted years to building a business
can find handing a majority stake over to an investor very daunting, yet many
deals require just that: As a rule of thumb, most PE deals involve a 40 to 65%
equity stake. If the investor takes a stake of less than 50%, the conditions
tied to that stake are likely to be more rigorous so that the investor can
protect its investment and ensure that it has the ability to direct the firm to
extraordinary returns in the long run. Once the equity stake is above 50%, the
terms are likely to be less stringent as the investor will have a voting
majority on the board. In either case, the deal will also involve board seats
and management interaction to ensure that the investor can actively mentor the
business owner to a successful outcome.
Whatever the level of equity
involved, business owners are likely to end up wealthier and businesses are
stronger after the deal. PE firms do not invest unless they are confident in a company’s
ability to grow. The capital it provides is the fuel that helps to make that
growth happen which, in turn, raises shareholder value.
The math is simple: a
smaller share of a large and rapidly growing company is worth more than 100% of
a small company. And even if voting control is given up, the investors will most
likely be committed to growing your vision and keeping the senior management
team intact. You and your team have created the success to date and is the number
one asset that the investor values most. PE will provide the funding to cash
flow the growth and provide management tools and expertise to fill the gaps.
Many deals involve one or
more of the following instruments:
· Common
stock. While equity stakes are often taken, common stock
offers less protection for the investor than preferred stock and is therefore
rarely the first choice.
· Convertible
preferred stock. Preferred stock that converts into common
stock, usually upon an initial public offering (IPO) or the sale of the
company. The preferred stock can be either participating (it gets a regular
dividend) or non-participating (no dividends are paid).
· Convertible
debt. A PE firm may seek to start the investment out as a loan
that is convertible into preferred or common stock upon certain events.
The ultimate structure of the
deal will depend on a number of factors and may include some or all of the
equity forms above, as well as a variety of terms and conditions that are based
on the circumstances of the deal and the needs of your company
Another factor to consider
in the structuring of the deal is timing: when the funds are received. Generally
it depends on what they are needed for; for example, funding for an acquisition
will be tied to the timing of the purchase. However, funding for a management
buyout may be staged over time to ensure that the senior manager being bought
out remains committed to the company’s future for some fixed timeframe.
Investors will aim not only
to build your company in the short run, but also to sell or liquefy their
investment in the long run. Most funds raised by PE firms have a 10 year time
horizon and are generally more patient than venture capital funds. Typical liquidity
events include selling the company to larger player in the marketplace, going
public, or being bought out as the company raises substantially more equity and
debt capital in the future. There are some traditional wealthy family funds
that don’t have any particular time horizon and consequently may stay in the investment
so long as it’s making economic sense to do so.
Most investors will consider
an exit strategy at the time they structure a deal. Others will work to have a
long run relationship with the intention of remaining a business partner until
the day that a firm with much larger resources is required to take a company to
the next step. In that case, the original PE firm may stay on as a minority
shareholder or the new partner may buy out the first firm’s interest.
Another
Key Consideration when seeking private equity is finding the right
balance between realizing your vision, gaining outside help in terms of
financial and executive experience along with a team that you can work with. You are more likely to create a successful deal if you seek a PE firm that shares your vision and has the resources to implement.
Contact us today to discuss
your situation and what you need to do next to get in front of the right PE group for you
business needs.
.jpg "Target Search Group - Private Equity Funding")
