5 minute read 23 Sep 2019
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Five misconceptions about private equity investment

5 minute read 23 Sep 2019
Related topics Assurance Audit Growth
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Private companies are sometimes wary of taking investment from private equity firms to help them grow. Here’s why they shouldn’t be.

Entrepreneurs who start their own companies do so for a variety of different reasons: some are passionate about a product they’ve invented or an idea they’ve devised, while others simply want to work for themselves and oversee their own time.

Whatever their motivation, sooner or later they will face the challenge of raising the funds they need to grow their business. In the most recent EY Global Capital Confidence Barometer, when private company owners were asked to name the most significant challenge to their growth plans, the most popular answer was “Access to capital” chosen by 16% of respondents.

There are several different ways in which privately owned companies can raise finance. In the early days, they often rely on their own savings, whatever funds they can muster from family members and friends, and bank loans. More mature companies will look at debt financing and may attract venture capital funding or investment from private equity (PE) firms. Eventually, the entrepreneur may reach the stage where the best option is to launch an initial public offering or even to sell the company.

Private equity investment

20%

of private company owners who named private equity as the primary source of finance they will be leveraging to fund their growth strategies in the next 12 months.

I hear private companies talk about PE investment a lot, and the EY Global Capital Confidence Barometer bears this out: when asked “What will be the primary source of finance you will be leveraging to fund your growth strategies in the next 12 months?,” 20% of private company owners named private equity financing, making it the second most popular choice behind private debt financing.

PE has the potential to help a company regardless of what stage it has reached in its development. If you have had experience with PE firms in the past, then you may already have your own opinion about the pros and cons that PE can bring for a company. The most important thing to keep in mind is that every PE firm is different, so in-depth discussions are essential before agreeing to a funding strategy.

When working with private companies, I often come across misconceptions about PE firms. Here are five of the most common:

1. PE firms always put their own interests before the company’s

PE firms are businesses, so they have a commitment to their stakeholders and owners to make money; but to do that, it’s in their best interests to help their investment succeed. They are experienced at creating “market-approved” value, which can be good for any stakeholders of the company they have invested in.

Indeed, an EY article published in 2018 makes the point that PE firms face increased competition for good investments in what is currently a seller’s market. It says: “PE executives increasingly must bring deep strategic expertise to assets in their portfolio, to transform those assets’ business strategies, processes or business models in ways that drive top-line growth.

By doing so, private equity firms will be in a position to build sustainable businesses that can thrive long after they have exited the investment.”

2. You will no longer be able to make any decisions yourself

Many PE firms are hands-off, but there may be some that take a more active role throughout the evolution of a company. To bring experience and knowledge to an investee, many PE firms would want to place people on the board or management teams. Although some business owners may regard this as undermining their position, others see having people join a company at a senior level as a good opportunity to learn and grow their own knowledge base.

There may be suggestions of ways to improve efficiency or processes, or to expand into new markets and products – but the PE firm is still likely to want the strategic input of the entrepreneur, as both parties should be looking to encourage growth and efficiency.

3. Your company will lose its identity and personal direction

By the time companies look for PE investment, they are usually well established in their market and will have had some form of outside investment. Those investors will probably already have had an influence on strategic direction, so the PE firm’s input can be the next step on the refinement journey. There is likely going to be some change when a new investor is brought into a company, but many PE firms will aim to sustain profitable parts of the business.

The PE firm is still likely to want the strategic input of the entrepreneur, as both parties should be looking to encourage growth and efficiency.

4. After five years the PE firm will exit, one way or another

Although the average PE lifecycle still seems to be five to seven years, a recent EY report showed that more PE firms are focusing on collaborations instead of full buy-outs, as well as longer-term investments with other investors on board. Many PE firms are holding on to investments for more than seven years these days.

It’s good practice to set strategy and goals on a three- to five-year timeline, whether you have PE investment or not. It gives direction to your company and allows an assessment to be made about what is needed to achieve your goals.

5. You will lose the company that you’ve built

This is always going to be a tricky one for some entrepreneurs: having spent years building something of which they are proud, do they really want to let it go? But I’ve also had lots of conversations with entrepreneurs who are already planning their next venture, or have plans for developing a new idea. Entrepreneurs rarely stay at the same company forever, and the experience of creating value and refining what has already been built will be very useful for the next time they join (or start) a company. There can be lessons to be learned from PE firms and those who work within them, so an entrepreneur may want to use these insights and relationships for their future endeavors as well.

Being optimistic in business is one of the strongest positions to take. There are undoubtedly some negative connotations about the role some PE firms have played in the past – but there are potential benefits to attracting investment that PE cannot be ignored.

Any entrepreneur who wishes to take their company to the next level may want to consider investment from PE firms and they should talk to a few different firms in order to appreciate how they operate. You should come away from the conversation with a clearer understanding of what both parties would want to achieve in an agreed timescale – and then decide how to continue your exciting growth journey.

Summary

Companies looking to finance their growth have a number of options. Private equity (PE) investment is a popular choice, but some private company owners are worried that it may mean losing control of their business. Randy Tavierne, EY Global Assurance Private Client Services Leader, examines this and other common misconceptions about PE investment.

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