Are You Too Small for Private Equity?

Owners of small and medium-sized companies frequently believe they are either too small for private equity, or that this form of funding would not coincide with their business objectives.

While most entrepreneurs have some experience with friends and family money or loans from a local bank, there comes a time when every maturing organization must take the next step. Particularly for companies looking to accelerate growth private equity might be the appropriate option.

Business owners should also remember that, while blockbuster deals often steal the headlines, the majority of private equity firms are devoted to making investments in lower middle market and middle market companies (usually companies with less than $500m in revenue). In addition, even some larger funds have shifted their focus of late, finding better value in increasingly smaller transactions.

Of course, choosing the right financial partner for your business is a decision not to be made rashly. For entrepreneurs curious about private equity, answering a few important questions about their business goals can help determine whether it might be a good fit:

Are you set up for growth?

Business owners who seek out private equity have likely determined that supporting growth requires a financial partner with a history of building and growing companies like theirs. Thinking about the key variables that could impact their expansion can help owners determine how ready they are to involve such a partner.

A major benchmark is whether a business has a strong and cohesive management team. Particularly if the owner plans to exit in full or step back his responsibilities in a meaningful way, a sturdy bench of second-in-commands is essential to keep the business running and help a private equity partner navigate the company in the early days of the partnership.

The state of a firm’s financials can often signal whether they are ready for the type of ambitious growth strategies a private equity firm will often pursue. Companies with steady and reliable cash flow are most often the strongest candidates for private equity.

It all comes down to business model, however, as private equity firms will want to not only understand the model but see potential for scalability. A palatable revenue model, customer base, competitive landscape and total addressable market make a company more marketable to discerning investors.

Finally, those looking for a financial partner or buyer might recognize that private equity investors often have higher risk appetites then lenders, family offices, or other types of investors.

Can they add value?

By taking on private equity funding, entrepreneurs will most likely be agreeing to involve an operational partner in their business.

When a private equity firm invests in a business, it will frequently take a seat on the board of directors or create a board if one does not yet exist. In addition, the investor will likely participate in other important affairs like formulating strategy and creating a timeline for future capital infusions.

In addition, many boutique private equity firms are almost always specialized by industry, which means they can add value through their expertise helping building similar companies and leverage existing networks in the space.

Are you seeking a full or partial exit?

Private equity could really be the answer for both full or partial exits. If a business owner wants a simple, clean exit, considering a sale to a buyout shop is one option. These firms pride themselves on being able to attract and integrate senior and managing executives once they bring a company into their portfolio. However, it is important to know that these investors often look to have the CEO stay on for at least a few months post-sale to manage the transition.

CEOs who want to retain some or all of their current responsibilities and just want to take some ownership off the table might consider selling a stake in their firm to a private equity firm. Investors frequently single out opportunities based on the strength and potential of the CEO, so business owners who have a strong vision and want to refocus on operations and accelerate growth may be just the kind of investment they are looking for.

Recently, opportunities have improved for companies considering private equity funding. Middle-market firms have been growing rapidly in recent years, and private equity is taking notice. It is certainly a seller’s market and, during these compelling times, business owners might find it particularly valuable to ask the right questions about whether private equity is right for them.