I was recently having lunch with a private company CEO and the topic of private equity came up. When asked if he had ever considered seeking a private equity partner to fund and support his planned growth initiatives, his answer was expectedly, “No, we don’t want to sell the business yet. We want to focus on growing the business.”
While I can certainly appreciate his perspective, that opinion is consistent among many business owners and leaders. Namely, that private equity is primarily a liquidity mechanism, not a preferred tool to fund and support company growth. Moreover, many business leaders often see their growth plans as incompatible with private equity, which they associate with high leverage and limited financial flexibility.
This perspective of incompatibility was also on display during the recent presidential election. Private equity firms were broadly characterized as opportunistic value extractors, rather than enablers of company growth and job creation.
While the purpose of this article isn’t to defend private equity (there certainly are some firms worthy of this negative characterization), significant evidence exists to suggest that, in general, private-equity-backed companies experience proportionally greater growth. This is particularly true for small-to-medium-sized businesses.
Private capital a key to growth
According to studies performed by GrowthEconomy.org between 1995 and 2009, U.S. private-capital-backed business grew jobs by 81.5 percent and revenue by 132.8 percent, compared to 11.7 percent and 28.0 percent, respectively, for all other companies.
In California, over the same period, the story was even more favorable to private equity. Private-capital-backed businesses grew jobs and revenues by 123.1 percent and 155.2 percent respectively, compared to 11.3 percent and 26.4 percent for all other California businesses.
While each situation is unique, there are many reasons why private-equity-backed companies experience greater growth.
Access to capital
With the continued tightness in the credit market for small-to-medium-sized businesses, private equity can be a source of capital to support growth initiatives.
Additionally, private equity firms often have preferred relationships with lenders, giving businesses more access to attractive and flexible debt financing where appropriate. With greater access to capital, companies can more quickly, nimbly and opportunistically implement growth initiatives.
Strategic guidance and ongoing operational support
A private equity partner can provide much-needed strategic and operational resources to support the company’s growth initiatives and ongoing operations. This often leads to more thorough and refined growth strategies, as well as more effective plan execution and implementation.
Private equity firms often have large networks of industry experts and experienced operators that they can bring to bear to support company growth and operations.
Increased capacity for acquisitions
Private-equity-backed companies are significantly more acquisitive than other private businesses. Acquisitions can be an attractive source of growth, allowing companies to increase their customer footprint, expand geographically, create greater scale and enhance capabilities in a relatively short time frame.
However, successfully identifying, executing and integrating acquisitions can be very difficult. Many business leaders don’t have the time or experience to effectively pursue acquisitions. Private equity firms generally have expertise executing acquisition strategies and can be valuable partners in supporting companies as they identify, negotiate, execute and integrate acquisitions.
Private equity can be a compatible and effective tool to support and achieve company growth — not simply a mechanism to achieve liquidity. While private equity is not appropriate in every situation, and not all private equity firms are growth-oriented, business owners and leaders should carefully consider a private equity partnership when evaluating their ongoing growth initiatives and funding options.
Josh Harmsen is a principal at Solis Capital Partners (www.soliscapital.com) a private equity firm in Newport Beach, Calif. Solis focuses on disciplined investment in lower middle-market companies. Harmsen was previously with Morgan Stanley & Co. and holds an MBA from Harvard Business School.
Often, business owners frame their own future in stark, binary terms — either I keep the business or I sell it. This binary thinking becomes most pronounced as business owners begin to contemplate retirement or an ownership transition. In reality, there are a variety of options that can span those two outcomes. For many business owners contemplating a retirement or transition event in the next five years, simply keeping or selling are suboptimal outcomes — either tying up critical value that could otherwise be used to diversify or foregoing the potential upside value in their business. In addition, these binary outcomes often overlook other important value drivers for business owners such as legacy, succession, well-being of current employees and the continuity of their current business. When evaluating which options to pursue, it is critical for business owners to first establish clear goals that define what they want to accomplish and when. This includes an honest assessment of their personal and professional desires and other value drivers (including those mentioned above). While these options each present unique opportunities and risks, they offer business owners a more tailored and optimized approach to achieving their future liquidity, retirement or transition objectives. Mezzanine debt recapitalization A mezzanine recapitalization will often allow business owners to seek partial liquidity or growth capital, without significantly diluting their ownership. Business owners can use the proceeds to diversify their holdings, while retaining equity control and the potential upside of the business. However, this option will add incremental, high coupon leverage to the business and could limit operational flexibility in periods of economic or business distress. ESOP — employee stock ownership plan ESOPs allow business owners a tax efficient roadmap toward partial or full liquidity while creating a mechanism for transferring ownership to employees. This allows business owners to maintain short-to-medium-term ownership and helps to preserve business consistency and legacy. It also rewards employees for their hard work and loyalty. However, once the ESOP has been established, it can significantly restrict ownership flexibility. MBO — management buyout MBOs allow business owners to achieve either partial or full liquidity while maintaining operational consistency throughout the organization. The MBO also rewards management’s loyalty and performance with the opportunity to acquire a significant stake in the business. However, MBOs often require management to partner with outside equity or debt providers — which can be time consuming and introduces new partners and influences on the business. Minority investment Minority investments from an outside investor (either institutional or individual) will allow business owners to seek partial liquidity, or growth capital, while maintaining a majority stake in the business going forward. The minority partner can bring valuable outside perspectives and skill sets to supplement your own. However, most minority investors tend to be only passively involved and often require onerous ratcheting provisions that could give them control if the business fails to meet operational objectives. Partnership transaction A partnership transaction will allow business owners to seek significant immediate liquidity while preserving some ownership and elements of control in the business going forward. Business owners can use the proceeds to diversify their assets, while maintaining potential upside in the business. The new partner can bring many valuable strategic and financial resources to bear to strengthen the business and pursue growth and value enhancement initiatives. However, new partners will seek elements of control and often utilize leverage to affect the partnership. Understanding the many options available to business owners will help lead to more tailored and optimal achievement of personal liquidity, retirement and transition objectives. Josh Harmsen is a principal at Solis Capital Partners (www.soliscapital.com), a private equity firm in Newport Beach, Calif. Solis focuses on disciplined investment in lower middle-market companies. Harmsen was previously with Morgan Stanley & Co. and holds an MBA from Harvard Business School.
If you’re contemplating selling or recapitalizing your business, there are a number of challenges ahead. Anyone who has followed his or her investment portfolio over the past year knows that we live in volatile and uncertain economic times. While 2012 began with positive momentum in the equity markets, the underlying fundamentals for sustainable global growth remain significantly challenged. The world’s developed economies remain highly over-leveraged, with the painful process of deleveraging still in its early stages. Deleveraging by its very nature is difficult, painful and costly — often accompanied by increased taxes, reduced spending and volatility.
This is most acutely seen in Europe, where a number of countries are grappling with the prospect of sovereign defaults and stringent austerity measures. While necessary, these austerity measures are creating a significant drag on near-term Euro Zone growth. Worse yet, significant defaults in Europe could trigger a severe economic contagion throughout the world’s economies, leading to global stagnation or even recession. While Europe is currently in the crosshairs, other developed nations, like Japan and the United States, face many of the same challenges.
So what does this all mean for business owners? First, we are likely several years away from a sustained and steady economic recovery. Second, volatility will continue to be common as long as unsustainable fiscal deficits and excessive leverage remain in the world’s developed economies. Third, the risks of a global contagion and even a double-dip recession are real. Bottom line — economic uncertainty and volatility will persist for years to come.
This new reality has significant implications for business owners looking to retire, pursue a sale or recapitalization in the next two to three years. If you fall into this category, below are some things to consider while navigating these uncertain and volatile economic times:
Establish clear goals that define what you want to accomplish and when.
Do you want to sell or recapitalize? Do you have a succession plan, or are you interested in bringing in an outside partner? What do you want your life to look like in five years? Having a clear set of goals will help you be more targeted and focused, thereby increasing the chances of achieving both your financial and personal goals.
Start planning early and be prepared to execute within favorable market windows.
Bullish and bearish swings in the market will likely continue. Being prepared to act quickly during these often short-lived market upswings will maximize your chances for a successful outcome. To do so, you will need to spend considerable time up front laying the groundwork for a sale or liquidity event, including speaking with advisers, identifying potential buyers or partners, and beginning to compile the necessary information for due diligence. Being proactive now will position business owners to nimbly approach buyers and partners during favorable market windows.
Diversification is a good thing.
For many business owners, the vast majority of their net worth is tied up in their business. In volatile and uncertain times, this can be very dangerous, as was clearly seen in 2008 and 2009. Seeking a partial liquidity event can be a prudent way to manage risk while maintaining elements of control and a significant stake in the business. The proceeds from the sale of part of the company can be used to diversify your assets. Perhaps most importantly, it allows business owners the opportunity to seek outside partners who can bring valuable strategic and financial resources to bear. A partial liquidity event will allow you to “take some chips off the table” while maintaining much of the upside in the business going forward.
Josh Harmsen is a principal at Solis Capital Partners (www.solascapitalpartners.com), a private equity firm in Newport Beach, Calif. Solis focuses on disciplined investment in lower middle-market companies. Harmsen was previously with Morgan Stanley & Co. and holds an MBA from Harvard Business School.