Each day the financial press reports another and larger business acquisition funded by so called “private equity”. I am pleased to report that these funds have discovered the Sarasota market. The Williams Parker business practice group has experienced a marked increase in “private equity” investments in all types of business transactions, ranging in amounts from as low as one million to the fifty million dollars. These investments have been outside of traditional real estate projects and have included businesses involved in insurance, financial services, software and related information technology, health care, scientific instruments, building products and infrastructure businesses.
What is “Private Equity”
Simply put, “private equity” describes private pools of capital seeking to invest in business transactions that do not require registration under state or federal securities law. These funds are normally administered by one or a small group of individual investment professionals working directly for a “private equity”. However, we have closed several transactions where investments have been made by a single individual investor.
The Triple P’s
What type of investment opportunities are likely to attract “private equity”? Simply put, such funds are seeking sustainable businesses that have the three “P’s”, “products”, “people” and a realistic “path to profitability”. Private equity funds are not usually interested in pure venture capital projects. In other words, the products to sustain the business need to exist and not be in the pure research and development stage. The products usually need a competitive advantage or other feature that can produce high profit margins. In examining the second “P”, the fund will need to have confidence that the existing management has the integrity, ability and willingness to do what it takes to make the business successful. Finally, a reasonable detailed projection of near term (3 years) profitability will be required. Private equity favors investment opportunities where success will lead to a need for more growth capital, which it can provide or arrange at an appropriate fee.
The “Deal Terms”
Private equity transactions take all forms and shapes, from convertible debt, “full bracket” preferred, “PIK” debt and straight equity to name a few. All forms, however, have several overriding characteristics. The investors will expect a return on investment commensurate with perceived risk, with the amount of equity based on an assessment of realistic capital needs, with little or no immediate payout to the founders of the business. The private equity investors usually will expect the founders to have contributed real cash, as opposed to “salary forgiven”. Funding will be made in stages based on meeting agreed upon operating and financial benchmarks, with the cost of the investment increasing if the benchmarks are not met. A majority of voting interest is not normally required because the private equity investor will have sufficient other control covenants in place to protect their interest and ensure that their investment is repaid before the founders share in the profits of the business. Unlike banks, “foreclosure” is an option that private equity investors equate to a complete loss of their investment.
Private equity funds guard their investors’ money with care. Therefore expect intensive due diligence into the business and the people. No two private equity transactions are the same. Every document will be heavily negotiated and is not likely to be a “form” document. Our experience is to expect a minimum of $35,000 in legal fees, which drives the cost of capital to a level dictating a minimum of $1,000,000 or more. This is not the type of legal work that lends itself to paralegal cost shifting. Once a private equity fund makes the decision to invest, expect the deal to close quickly. Management and their legal team must be prepared to respond in a timely manner.
“No Talking to Strangers”
How do you find a private equity fund? The industry tends to be a “club” where a business plan needs an introduction to even be read. Private equity funds prefer to do business with professionals with whom they have done business before. Each fund tends to favor one or more business segments. If a fund is introduced to a viable project outside of its area of interest, the fund advisors will know which funds to contact that may have an interest. There are investment bankers that specialize in advising businesses seeking capital from private equity sources These specialists typically charge a monthly retainer to assist in preparing the presentation materials for a capital raise, with significant compensation paid in the form of a success fee based on a percentage of the capital raised. These percentages typically range from 7 to 15 percent.
Should you have further questions about “private equity” financing or require assistance for a particular project, please contact Robert W. Benjamin at (941) 329-6615 or firstname.lastname@example.org. or R. David Bustard t (941) 329-6629 or email@example.com.