Accessing adequate capital to scale up a business can be a daunting task. Great ideas, innovation and market opportunity would waste in the absence of capital. Such Ideas, innovation and opportunity would migrate to firms with adequate capital or the capacity to attract it. Suffice to say that underpinned in most business failures is the lack of adequate funding. The entrepreneur as the driver of business must be able to anticipate funding requirements for the respective stages of the business as well as grow the business to attract the needed capital throughout its life. The early and growth stages of the business being the most critical to put the business on firm footing.
Most entrepreneurs are able to raise the needed capital to kick start their business but would usually face challenges raising capital to scale up. The question is usually whether the business will be able to “attract” the required funding for expansion. The key word, therefore, is “attract”. In other words, the business must be interesting enough to catch the attention of would-be investors with the financial war chest to take a bet and risk their funds on the business. This is typically the case with most institutional investors including private equity funds. Today, private equity funds are a good source of funding for firms that are seeking to grow and expand their business. Nigeria and other Africa countries have been beneficiaries of private equity investments. A good number of the private equity funds that are being raised on the continent are also seeking viable investment opportunities in Nigeria and across the African continent.
On this note, it would be important to share with entrepreneurs seeking to grow and expand their business in Nigeria, across West Africa and indeed the continent some of the essentials of attracting private equity funding.
How Private Equity Investment Works
Private equity funds, like any other financial investor, will apart from providing capital, also have the goal of making reasonable returns on the investment. These funds will seek out to invest in businesses with capacity to grow and return money in multiples of capital invested over a period of time; the businesses with the potential of making higher returns on investment within a short payback period will be the most attractive. The ability of the business to scale up within the short to medium term is therefore essential. The sweet spot for the investment horizon is about three to five years by which time the business should have expanded and returned on the investment. In any case, where it is justifiable, private equity investors are willing to wait for longer periods of time to actualise the investment.
In making the investment, the private equity investor may (a.) take up shares, debt or a mix of equity and debt for the investment; (b.) have management oversight of the business through the board, board committees and/or executive committees; (c.) insist on appointing key management personnel of the business. The rationale is to have some level of oversight and/or control on the management of the business to ensure that the business is being steered in the direction of growth and profitability.
What Private Equity Investors Look For
1. Entrepreneurial Spirit and Strong Management Team
The private equity fund will not be involved in the daily management of the business and therefore will seek out for sponsors and management teams that are eager to advance the course of the business, are hands-on, resilient, embracing innovation and new way of thinking, ability to attract talents as well as other traits that distinguish entrepreneurs. The management team’s track record will be subjected to scrutiny to affirm the strength and resilience of the team at delivering growth and profitability.
The experience of the management team and the ability to deliver the future of the business is also critical. The investor will want to be comfortable with the management team’s ability to craft and execute on the strategy of the business, leverage on relationships and alliances, enhancing efficiency by leveraging on technology as well the motivation and cohesion within the management team.
2. Good Corporate Governance
Transparency of management and the governance structure of the business is crucial to private equity investors. Sponsors and management team must put in place internal control measures that ensure adequate oversight of the financial and operational elements of the business. The internal control policy of the business should also provide avenues for escalation of risks to the attention of management and board for necessary and timely action. Dominance of management over the board will be a turn-off. It is therefore important to have in place an active board whose members (particularly the non-executive members) bring value to the business in terms of industry experience, network and ability to provide leadership and oversight for management team and to the business.
Alignment of interests is important to ensure that the business achieves its growth potential and realisation of the investment. This means that the private equity fund and the sponsors of the business must swim or sink together. Private equity firms will not support a business or corporate structure that allows the sponsors to benefit from the business at the expense of the private equity fund. Therefore, it is typical to see the private equity fund and the sponsor hold interests in the same type of instruments in the business so that both parties will share the same benefit and risks of the business. In no circumstance will the sponsors hold any interests in the business or enjoy any benefit that will give the sponsors an advantage over the private equity fund.
4. Ability to Scale Up Rapidly
Private equity firms are looking for significant returns. Therefore, the ability of the business to grow rapidly over of the short to medium term is critical. This is will involve determining the market share of the business relative to the size of the industry and whether the business is well positioned to grow its share of the market by leveraging on its strategy, technology and relationship. The sponsors may also to show that the business has gained significant traction in an untapped market of potential customers and would require additional capital to consolidate on its effort within the industry to service these customers.
5. Ambitious Business Plan and Sustainable Cash Flow
The business plan must communicate the growth potential of the business. It must be realistic and supported with facts outlining the market needs, competition, review the business’ strengths and weaknesses, identifying critical factors and what must be done to scale up the business. The company’s track record and ability to generate considerable cash on a sustainable basis, that is, an attractive EBITDA (earnings before tax, depreciation, interest, depreciation and amortisation) will be an attraction for the business considering that this will be a boost to the company’s enterprise value.
6. Clear Exit Strategy
Private equity funds will invest for a couples of years and would expect to exit their investment. It is therefore important to understand the fund’s approach to exit and have the sponsor and management team buy-in to this objective to ensure an exit route for the fund. Since the return on investment to the fund depends on the ability of the business to growth and expand over the investment period, it is important for the sponsor and management team to demonstrate their ability to deliver on this goal from the outset.
7. Synergy with Existing Portfolio Companies
Private equity funds are also attracted to businesses that are able to provide synergies with other companies in their portfolio. It is important to understand the objectives of your would-be private equity investor and their investment strategy. This could be useful in identifying synergies that can be created from investment by the private equity fund. The synergies will useful in delivering operational efficiency and reduction in the cost of business.
Finally, it is important note that partnering with a private equity fund will involve a high degree of openness as the private equity fund will seek to know everything about the business relating to the past, present and future plans for the business. At times, the private equity investment process may involve an extended period of due diligence and agreeing on the appropriate valuation of the business may also involve long-drawn negotiations between the fund and the sponsors. However, the investment is usually a rewarding experience for the sponsors and management team. Businesses with private equity investment become more efficient, better run and attractive for further funding.
It is important that portfolio companies understand their would-be private equity investor and its investment strategy. The sponsor and management team of the portfolio company should understand the implications of the investment agreements to be signed with the private equity fund. This will necessitate seeking legal advice by sponsors and management team of the portfolio company in order to maximise the benefit of the investment by the private equity fund.