Raising Capital in the Private Equity Market

Raising Capital in the Private Equity Market

Richard Vinci

Managing Partner

Newbury, Piret & Co.

For the owners of family businesses, access to fairly priced capital from dependable sources can be a crucial component to the successful operation, management and growth of the business.

More often than not, outside capital is provided by the respective companys commercial banker.  In favorable times, this relationship may be all that management needs to secure the capital required to fuel the implementation of its business plan. However, what does the family business owner do when the commercial bank is “tapped out” or when credit policies and regulatory pressures make borrowing difficult, restrictive or unavailable?  When the credit markets are challenging, it is frequently valuable to explore the strategic financial alternatives available in the Private Equity market.

What are the signs that the capital markets are pulling back? Aside from the often dire statistics and information provided by business and news publications and the leading indicators, the following are some key signals:

1. Commercial debt markets are very restrictive, with deals done under stricter terms and conditions

2. Venture Capital is less plentiful and more difficult to access

3. Larger corporations are pursuing a “back to core” business strategy, rather than a policy of making investments and acquisitions, hence strategic investors are harder to identify and interest to invest.

4. Public equity is severely limited and IPOs are effectively non-existent for middle market companies

As an owner, you may have a great idea for expanding your business, but you cannot convince your banker to finance your needs because a financial ratio has not been met, you have reached the institution’s lending limit, debt service coverage is too lean, or a plethora of related internal, external and regulatory considerations.  It can all add up to frustration and potentially missed opportunities. Strategic alternatives for growing, recapitalizing or exiting one’s business should not be entirely beholden to economic cycles and the state of the capital markets.  If an owner does not implement the appropriate strategies at the right time, the owner can sacrifice a large amount of the company’s worth.

Notwithstanding the foregoing, an ample supply of capital is currently available for those with access from the Private Equity markets to finance a wide range of financial strategies.  The problem is that many business owners do not know what Private Equity is or how to access it in a meaningful way for their business.

What is Private Equity?

Private Equity can be broadly defined as privately negotiated transactions in public or private companies.  While more Private Equity transactions involve investments in private companies, they can range from the financing of early stage companies, to investing growth equity into an expanding company, to buying out mature public or private enterprises.  Private Equity investments are typically structured as either non-control or control positions.  They can work with your existing lenders or be enhanced by building a tiered capital structure incorporating non-regulated finance companies and mezzanine capital providers. Private Equity investment can occur at virtually every stage of a company’s life cycle.  Venture Capital, Late Stage Private Equity, Mezzanine Financing and Distressed Debt are four common subclasses of Private Equity.

Qualitative and Quantitative Considerations in Accessing the Private Equity Market

For the uninitiated, raising money in the private market can be a challenging proposition.  Private Equity is an often overlooked capital alternative to commercial debt financing.  While many lenders and equity investors are eager to finance middle-market businesses, challenges do exist to successfully arrange financing.  While the market is competitive, lenders and investors are still scrutinizing risk as closely as ever.  Therefore, it is imperative that a company present itself, its planned use of capital, and its business clearly and in a compelling fashion.

Accordingly, there are many factors to consider in accessing the Private Equity Markets.  It is not as simple as evaluating which group has the lowest rates and terms.  Certain investors focus only on specific industry sectors where their team has core experience.  Some firms pride themselves on offering strategic guidance and operating expertise.  Others are more financially oriented and are not as effective in providing intellectual capital and counsel to management.  It is important that the financial sources which are approached are currently investing or lending to companies like yours.

It is important to protect the company’s confidentiality and reduce the time commitment by management by only soliciting qualified investors for the specific opportunity while still creating a competitive environment within the investment community for the individual transaction.

The Role of a Financial Advisor

The seasoned financial advisor will create material that best presents the company and it value proposition.  In selecting experts, the business owner should not only examine objective measures, but also take into account subjective qualities such as personal style and people management skills.  The advisor’s style should be compatible with that of the company’s management.  An effective advisor will have experience to approach only qualified investors for a particular company and will have prior relationships with those investors that will assure access and attention to the client company’s project.  Therefore, when seeking to explore alternative financing strategies, it is helpful to select the advisor early in the process to facilitate coordination between management and other professional services providers such as the company’s attorney and accountant.  This can also facilitate input on valuation, structure and related considerations before approaching financial sources which can preserve credibility and maximize value.

In closing, when working with the Private Equity community it is important to effectively manage the process and to treat the first contact with prospective investors as if it may be the only chance you will get.  A clear and focused strategy to providing a compelling value proposition is essential.  By managing a discreet and efficient process that focuses on maximizing value, the Private Equity Capital Markets can be the key to accessing untapped financial resources to enable you to execute your

company’s strategy.

Types of Private Equity

Venture Capital (“VC”)

Venture Capital is an important source of capital for start-up companies and those in the initial stages of developing products and services that do not have access to more conventional sources of financing.  Most venture-backed companies are at the development growth stage in sectors such as life sciences and technology.  Several stages of VC investing exist often marked by financial and/or operational milestones.  Valuations can increase as these companies grow and they proceed from round to round.

Late Stage Private Equity

Late stage investing is targeted at relatively mature businesses and typically is used to fund growth, acquisitions, recapitalizations and Buyouts. Buyouts, also referred to as “leveraged buyouts” or “LBO” or “management buyouts or “MBO” involves the acquisition of a relatively mature product or business.  As the name implies, LBO’s and MBO’s make use of significant amounts of debt.  Returns are generated through operational improvement, asset appreciation and/or leverage.  They are often used in the acquisition of industrial or consumer-oriented businesses.

Mezzanine Debt

Mezzanine debt has a fixed maturity date.

It is senior to equity and junior to senior debt.  Mezzanine investors enjoy downside protection through the equity cushion beneath them.  They are compensated for the higher risk they have assumed in relation to senior debt holders through higher interest rates and often “equity kickers” in the form of warrants.   The interest portion of the mezzanine security’s return typically comes in the form of a cash coupon and/or payment-in-kind interest (i.e. compound interest that is deferred until the final maturity) which is often structured to assist companies in preserving cash flow.

Distressed Debt

Distressed Debt Private Equity firms buy corporate notes of companies that have either filed for bankruptcy or are likely to do so in the future.  There are two distinct strategies within distressed debt investing.

1. Debt to Control – A strategy wherein the investor seeks to gain control of a company through a bankruptcy or reorganization process.

2. Trading Strategy- This strategy is typically employed by a hedge fund in which the investor purchases distressed debt from a significant company and seeks to profit as the underlying company recovers and the debt appreciates.