In the realm of business expansion, Private Equity (PE) firms emerge as strategic partners for entrepreneurs seeking to fuel their ventures. Despite not being as widely recognized as banks or stock exchanges, private equity serves as a crucial source of capital, offering a solution for business owners aspiring to foster growth. However, many entrepreneurs remain unfamiliar with the intricacies and workings of private equity.
Private Equity (PE) represents a form of investment capital derived from investors such as pension funds, high-net-worth individuals, or endowment funds. Functioning as entrusted entities, PE firms revolve funds from initial investors. Unlike banks, which typically provide loans and demand collateral and monthly repayments, private equity investors engage differently. They inject capital, for example, USD 20 million or IDR 30 million, in exchange for shares. The receiving company isn’t burdened with monthly repayments or the need to provide asset collateral.
Each private equity firm possesses its unique investment style. Some prefer a minority stake, holding less than 50% of shares, while others seek majority control. The amount of capital placed in a single company by private equity varies widely, with mandates and strategies dictating preferences, ranging from above USD 100 million to smaller sizes like USD 5 million. The big private equity firm like BlackRock, Blackstone, Apollo Global Management, KKR, The Carlyle Group, CVC Capital Partners, TPG and Thoma Bravo very possible to invest more than USD 100 million or event USD 500 million per investment. But usually local PE that operates only in certain country, can invest in small size investment.
The origins of private equity funds usually stem from the proactive efforts of founders to gather and manage capital. The extensive networks of these founders are crucial for attracting investors. Typically, PE owners have strong connections with individuals and entities capable of providing funds for development.
Why would investors trust their funds to PE firms? The answer lies in the desire for their money to grow and multiply. Unlike funds left idle in a bank, investors seek maximum returns. The ideology is straightforward – money’s purpose is profitability. It holds no loyalty to a specific country or location but gravitates toward opportunities wherever capital can flourish.
The investment approach of private equity firms into target companies usually follows two patterns:
Firstly, they may buy existing shares from current shareholders, leading to a change in ownership.
Secondly, the target company issues new shares, subsequently purchased by the private equity firm. This method is often favored as it channels funds into the company’s coffers, enhancing its overall capital. However, the process can be case-specific, sometimes involving a combination of both approaches.
Thirdly, in addition to equity investment, private equity firms may buy convertible bonds issued by companies in need of funds. These convertible bonds can be converted into shares when they mature, provided the debtor company cannot fully settle its debts.
Notably, private equity firms typically invest in rapidly growing companies with a strong profit margin. Why? Because they must yield profits for the initial fund contributors. Private equity firms commonly demand an Internal Rate of Return (IRR) above 15%, emphasizing the need for substantial returns when selling their shares to other parties. Unlike banks, private equity firms only seek gains when their shares are sold to another entity.
It is crucial to understand that private equity firms are more inclined to invest in companies with limited access to bank loans. These companies may have already leveraged their equity for bank loans, making it difficult for them to secure additional loans due to high debt-to-equity ratios. Typically, banks hesitate to provide loans without collateral, and private equity firms step in to fill this financial gap.
Who is an Ideal Partner for Private Equity?
First Scenario:
Companies poised for expansion, possessing a promising business but lacking funds for growth. Additionally, if they find it challenging to secure bank loans due to high debt-to-equity ratios, private equity can be a crucial partner.
Second Scenario:
Companies planning to go public in the next 2-4 years. Partnering with private equity enhances the company’s book value and capital structure, creating a stronger appearance for an Initial Public Offering (IPO) later on.
Third Scenario:
Companies looking to acquire another business but lacking the funds. In this case, private equity can be invited to invest and become a shareholder, facilitating the acquisition process.
Fourth Scenario:
Companies aiming to buy shares of another business, possibly owned by an aging or disinterested owner. Private equity can be engaged to invest, allowing the current management to retain operational control.
Private equity investments typically have a short duration, ranging from 3-7 years. Post this period, the exit strategy varies, including selling shares through an IPO, selling to majority shareholders, or conducting a trade sale to significant investors or strategic groups interested in the business.
In conclusion, private equity firms are selective about their investments, favoring companies with proven management capable of steering existing businesses towards accelerated growth. They are willing partners for companies seeking additional capital for expansion or looking for strategic solutions to revitalize their businesses. If your company is on the lookout for an investor, consider the potential benefits of partnering with a private equity firm.
Wish you luck !
