Most business owners have heard all about venture capital funds as a source of funding for startups and early-stage companies. But what about more advanced profitable companies -- where can they go for their millions?
Private equity -- or "PE" -- is the umbrella term for a broad range of funds that pool investors' money together to increase their buying power. Unlike most mutual funds, in which fund shares trade on active public securities exchanges, private equity funds attract investors who are willing to hold shares in privately held, non-traded funds (hence the term private equity). These big-dollar private equity funds are trolling the business landscape for new investment opportunities -- and that means you.
The good news for established business owners is that there are many more private equity funds investing in growth-oriented, revenue-generating companies than in venture-capital-oriented, high-technology companies with unproven business models. Plus, these funds are also much more inclined to invest in low-tech industries, multi-location service companies, franchise operators and Main Street manufacturing businesses than venture capital funds.
So, what can a private equity fund do for you? Here are five common investment scenarios that might help your company as its funding needs evolve.
- Buy out the company. Private equity funds can buy 100 percent of the outstanding shares of your business, cashing out founding shareholders and previous investors. The founder may be retained to continue to manage the business, or the buyout fund can install a whole new senior management team and board of directors. The great thing about private equity funds is they have hard cash on hand to buy companies, thereby creating less uncertainty for business owners.
- Cash out the founder. It's also possible to buy out just the owner-founder, while keeping existing investors in place. Sometimes owners sell because of illness, divorce settlements, retirement, boredom or unsolvable squabbles with investors. Founder buyouts are also possible when employees partner with a private equity fund to finance a "management buyout." Typically, private equity funds are more attracted to cashing out a founder if a controlling stake is available.
- Buy out existing investors. Old investors can become "tired" investors, especially if they've had their money tied up for five or more years in a privately held business. The terms of these transactions can be tricky but doable, especially if the underlying company still has considerable financial upside ahead.
- Invest in expansion capital. Owners of prosperous businesses are often tapped out. Every business and personal asset has already been pledged as collateral on bank loans, jeopardizing the company's growth prospects and competitive standing. Private equity funds can help prosperous business owners continue their winning ways with funding for acquisitions, new product line development and geographic expansion.
- Recapitalize struggling businesses. Private equity funds are not scared of investing in companies with "hair on them," provided they are good candidates for a near-term turnaround. In private equity lingo, "recap" funds seek to recapitalize or restructure a company for the future.
- But don't expect fund managers to support the same business plan and management team that got the company in trouble in the first place. Recap and "special situation" funds are looking for clever ways to reinvent a revenue-generating business and build it back to profitability.
What's most important for business owners to know about private equity investors is that they are financial investors. Unlike corporations that might buy all or part of a business for strategic operating advantages, financial investors make their decisions based solely upon their projected return on invested dollars. They may be sensitive to a founder's wishes, but not sentimental in negotiating final deal terms.
Susan Schreter is a 20-year veteran of the venture finance community and a university educator in entrepreneurship. She is the founder of TakeCommand, a community service organization that offers the largest centralized database of venture capital funds, angel investment clubs, incubators and microfinance lenders in the U.S. Ask her your questions at firstname.lastname@example.org.