It is a big decision to bring equity into a company. Typically, equity is brought in when debt alone is not appropriate or sufficient to satisfy the company’s needs. Equity can be minority or majority, and it can be structured in infinite ways. Regardless of the type or structure, this step also means that you are adding one or more partners. So, if you have the good fortune of being able to choose among two or more equity suitors, do your homework. The following are some things to consider:
Beware of the false minority (i.e., the devil is in the details). Minority equity often is viewed as more attractive because of the perception that “control” is retained. While this certainly can be the case, great attention must be paid to the terms of the investment, particularly to the rights of the investor in the event things don’t go as planned.
Frequently, minority capital will have performance hurdles or other identified events (like defaults under loan agreements), the failure or occurrence of which will give the minority investor greater rights and authority — sometimes control of the company. When bringing in minority capital, engage a qualified, experienced attorney and understand the rights you are giving away.
The power of the majority (i.e., it’s better to own half a watermelon than a whole grape). The remainder of this discussion will focus on investors who purchase 50 percent or more of the company. Your decision to accept equal or majority investment must also come with the acceptance that you now have a partner or partners and that there will be changes — ideally, for the better. A good equity partner can help create tremendous value. A bad equity partner can make your world miserable. At a minimum, look for these qualities in a potential partner:
Track record. Be sure that whatever you are hoping to gain from the partnership (other than capital) your potential equity partner has successfully done before. Whether it’s building a sales team, developing new products, cutting costs, developing infrastructure, going public, acquiring add-ons, franchising, etc., verify they have done it well. Study their track record, and ask the hard questions. If they are what they represent, they will respect your diligence. If they aren’t, you will, hopefully, avoid a mess.
Expectations. A good potential equity partner will spend considerable time with you and your team understanding your vision and making sure it aligns with theirs. When disputes arise between investors and their operating partners, it most often is the result of misaligned expectations. On the other hand, if done properly, the equity structure should be based upon your and the investor’s collective vision of the future.
Hands-on, hands-off. Prior to closing the investment, it is imperative that you and the potential investor agree regarding how you will work together. Some investors are only comfortable if they are deeply involved in operations. Others expect only to attend quarterly board meetings unless things go badly. We are in the middle. We like to spend significant time supporting development of the strategic plan, and then seek to support our operating partners any way we can in executing the plan.
Chemistry. Although hard to quantify, you should feel good chemistry with and trust for your potential partner. As you may be together a long time and face great challenges with your partner, this consideration should not be compromised.
A good equity partner can accelerate your growth and success and help you create and realize a vision far grander than you might otherwise have. A bad equity partner can be disastrous. Be disciplined, and choose wisely.
Dan Lubeck is founder and managing director of Solis Capital Partners, a private equity firm headquartered in Newport Beach, Calif. Solis focuses on disciplined investment in lower-middle market companies. Lubeck was a transactional attorney and has lectured at prominent universities and business schools around the world. Reach him at firstname.lastname@example.org or visit www.soliscapital.com.