Private equity firms are cashed up and ready to invest according to the most recent research released by the Australian Private Equity and Venture Capital Association (AVCAL)1.
Australian private equity firms raised $2.7bn in the 2015 financial year (triple that of the 2014 financial year) and invested over $3.3bn. The increased activity in 2015 suggests a return to market confidence in private equity following the Global Financial Crisis.
Interestingly, in spite of media attention around big deals such as the recent Baring Asia takeover of SAI Global, the majority of private equity investments are being made at the smaller end of town. Over 53% of investments in 2015 were made in enterprises valued at less than $50million, with a significant proportion being in young, smaller SMEs.
With increasing funds flowing into private equity, there’s opportunity for middle-market businesses to attract investment and reap the rewards of a private equity partnership.
What is private equity?
The term private equity generally refers to external investment in companies that are not listed on a stock exchange or which can be privatised in the event that they are listed. Private equity investments are usually characterised by their transformational nature.
Firms raise their money from a variety of sources such as superannuation, other investment funds, and private investors on a fund by fund basis. These funds each have a life of about 6 to 10 years and enable private equity to invest in defined businesses over the life of the fund. The investments need to be invested and exited over this period.
Generally, private equity firms will look for investments in which they can achieve a rapid growth in the value of their investment over a controlled period of time. The value added to the enterprise is then typically realised through a trade sale, initial public offering, recapitalisation, on-sale to another private equity investor, or in some cases the sale back to the original owner.
The private equity industry can be divided into two areas; private equity and venture capital. The term private equity usually refers to investments in more mature enterprises to help fund their future growth. Venture capital, usually refers to an investment used to help build or grow an early stage fast growing enterprise. Venture capital is generally seen as a riskier investment as there is often only a limited trading history in terms of the enterprise or industry at this early stage of investment.
For the purposes of this article the umbrella term private equity has been used to refer to both private equity and venture capital investments.
What are private equity firms looking for?
There are numerous private equity investors in Australia as well as international funds that invest in Australian businesses. Funds usually specialise in targeting either SME businesses or larger businesses including listed companies.
Typically, those funds in the SME space are interested in fast growing businesses or those require capital to grow. The businesses they target generally have revenue between of $10m to $200m and EBITDA of at least $3m to $5m. The larger funds usually target both private and listed companies with revenue in excess of $200m, and EBITDA or at least $10m.
Although there are differences in the size of business which funds like to target, there is a consistent theme amongst many private equity investors in what they look at in an investment. This includes their ability to add value based on previous experience, good management, growth and a robust and differentiated business model
The industry sector also plays an important role in investment choices. A business in a high growth industry may be perceived as a better investment than a business in a low industry regardless of past performance or forecast results.
From our experience with a number of private equity investors, although their interest generally spans a number of industry sectors they have recently shown particular interest in businesses in financial services, healthcare, life sciences and information & communication technology. In particular, we’re seeing interest in those businesses that have developed disruptive business models within their industries.
Industry aside, a number of key factors differentiate a good investment from a bad, they include:
- A strong management team (independent of the current owner) – with a solid track record within their business.
- A unique product or offering – with clear differentiation from its competitors, multiple and recurring income streams that are not dependent on any one product or customer, and little chance of becoming redundant in the near future.
- Intellectual property – ownership and protection of its intellectual property.
- A focused business model – showing realistic goals and a track record of achieving forecasts.
- A clear exit strategy – there should be a definite market for the business whether through a trade sale or IPO.
It is important that the business owner’s goals and objectives are consistent with those of the private equity firm, as the investment by both parties is a partnering arrangement with the same shared common objectives.
The key to attracting private equity funding lies in the ability to view the business as an investment. Often the business owner is too caught up in the day to day running of the business or the excitement surrounding their idea to view the business dispassionately. Preparing a comprehensive business plan which articulates the strategy, the growth opportunities supported by market research, and the financial framework for the business including realistic forecasts will help you to view your business objectively as an investment.
Benefits of partnering with a private equity firm
The high rates of return expected by the private equity firms together with the idea of selling some of the equity in your business are often seen as disadvantages to business owners. Why then would a business owner seek this form of funding?
For many business owners in the start-up or expansion stage there are no other options. Without tangible assets or a strong profit history few banks or institutional investors are willing to provide funding to the business. Moreover, many business owners are unable to or hesitant to provide the required capital themselves due to their age or other personal reasons. Private equity fills this void.
Private equity firms offer business owners more than just funding. A good private equity firm will act as your partner and will be able to use their track record and experience in investments to add value to your business. It is after all, in their best interests to maximise the value of your business. A private equity firm may do so in a number of ways including:
- Accessing bank funding at optimal rates due to their track record with investments with banks
- Providing experience through in-house consulting
- Assisting in strategic planning or serving as a member of the board
- Assisting in the recruitment of management or directors
- Identifying and providing access to strategic opportunities
- Encouraging business connections and knowledge sharing between different businesses within its portfolio
- Generating good publicity and an attractive name for the business through the firm’s reputation.
In an increasingly competitive environment the experience and connections offered by a private equity firm (in addition to capital) can provide the necessary tools for business success. It is important, therefore, to find a private equity firm that is suitable to your business’s needs. When considering private equity funding a number of questions should be asked including:
- What is the private equity firm’s experience in this industry?
- Which companies currently make up the firm’s portfolio?
- How many funds has the firm raised and what has been their average return on each fund?
- What investments has the private equity firm not performed well in and why?
- Is there the opportunity to meet with some of the former and current business owners which the firm has invested in to confirm their reputation?
- What conditions will be required as part of the investment, i.e. will a member of the firm sit on the business’s board? Will the accounts need to be audited? Will there need to be more directors including an independent director?
By asking such questions you will not only be better positioned to make an informed decision but will display to the private equity firm that you are serious about the transaction and understand the capabilities required to run a successful business.
William Buck’s advisors have extensive experience working with private equity firms across Australia, New Zealand and internationally. Our team can help you assess whether private equity funding is right for you and identify the most appropriate firms to help you grow your business. For more information, please contact your local William Buck advisor.
1 Funding the New Economy; A ‘Scale Up’ Policy Blueprint, June 2016. AVCAL