The Seducers

The investors have come calling, seducing you with multimillion-dollar deals. Before you lose your head, consider what can go wrong. 8 private equity pitfalls and how to avoid them.

Roark Johnson

KRISTEN OSOLING, CEO, Re:Invention

Tweet

Daniel Hennessy

LAWRENCE NG, CEO, Oversee.net

"Wanted: Fast-growing company with smart CEO, interested in millions of dollars of investment capital." For an entrepreneur, can there be a sweeter combination of words in the English language? These days, that sentence or some variation of it seems to pop up everywhere. You can hardly open a newspaper or flip on the financial news without hearing about another larger-than-large private equity deal. Get together with a group of business owners, and it won't be long before you're hearing stories about unsolicited phone calls from would-be investors or millions closed on by a once-bootstrapping entrepreneur.

In the third quarter of 2006 alone, investors put $6.2 billion in nearly 800 deals, according to a recent report by PricewaterhouseCoopers and the National Venture Capital Association. Private equity investors, which include angel investors, venture capital firms, buyout firms, and others, either take a public company private or acquire all or part of a privately held company, hoping to make a profit when the company either goes public or is otherwise sold at some point down the road. Names you know, such as the Four Seasons (NYSE:FS), Outback Steakhouse (NYSE:OSI), Hertz (NYSE:HTZ), Neiman Marcus, and Dunkin' Donuts, have recently closed major private equity deals, as have hundreds of smaller companies that don't grab the spotlight. It surely is an exciting--maybe even an exuberant--time to be an entrepreneur.

And that should make you sit back, take a deep breath, and raise at least one skeptical eyebrow. For while it seems that there could be no downside to this, the road to your private equity deal is not without perils. Seek this kind of an investment when you shouldn't, or choose the wrong investor, or botch the negotiation, and it could cost you a really bad five or seven or nine years--or even everything you've worked so hard to build.

It has become a cliché to liken the private equity investment to a marriage. A good one is really, really good and a bad one can be ruinous, financially and emotionally. Like a marriage, a lot of the story is written at the very beginning--during the courtship phase or, in industry speak, pre-money. You're wooing the investor, and the investor, in search of deals, is also wooing you. "I don't think there's any doubt about it--it's a dance," says Alex Temel, partner at law firm Proskauer Rose in Boston and a specialist in private equity deals. "It's a dance that starts when you first meet the investor and lasts until the sale on the back end." As much as possible, you want to lead the dance and exit the floor with a flourish and a smile--and a nice deal for you and your company in your back pocket.

Unfortunately, entrepreneurs often walk away from these encounters feeling spun dizzy. Why? Many entrepreneurs are simply unprepared for their dealings with private equity investors, says Rick Rickertsen, managing partner at Pine Creek Partners, a private equity firm in Washington, D.C., and author of Sell Your Business Your Way. They plunge into pitfalls that could be easily avoided. Here then, the eight most common blunders that entrepreneurs make the first time they consider taking on a private equity investor--and some tips for steering clear of them:

1. You Move Too Fast

Lawrence Ng founded his Los Angeles-based Internet advertising company, Oversee.net, in 2000, at the age of 21, with $10,000 of funding courtesy of his and his partner's credit cards. Two years later, his company was profitable and growing, and the private equity investors came calling.

Ng still remembers the first time he had a serious encounter with a potential equity investor. It started with a phone call from an analyst, quickly proceeded to a second call, and then a meeting. The investors were saying all the right things, Ng recalls: "'We are experts in this space, we've taken so many companies public, we see ourselves as partners, not as hands-on managers.' It all sounded very nice." It went from nice to exciting when the investor put a value for Oversee on the table. "Here's this professionally managed investment group saying, 'We believe in you, and we feel you can be valued at this.' It felt like, 'Wow, I've been validated." Ng won't say how much "this" was. But he will say that his reaction was "Holy wow!"

There's something profoundly satisfying when you hear that the company you've slaved over not only has been worth the effort but also is only at the start of its potential profitability. The problem: The excitement this can generate might short-circuit your brain and cause you to have fantasies about how you'll spend all that money before you even leave the meeting. At the very least, you might convince yourself to overlook potential downsides of the deal in your rush to move your company to the next level.

Avoid this pitfall by not being in such a huge rush to get a deal done. Take as much time as you need to reflect, to bounce the details off your most trusted advisers and fellow entrepreneurs, and to otherwise deeply research the deal. (More on how to best do all of this in a moment.) Although Ng was sorely tempted by the first deal he was offered, he did the right thing: He took time to think about it. After a cooling-off period, he decided that his company had more room to grow, and he could get a higher valuation if he waited before taking on investors. He passed on the proposal and has yet to take on investors.

 1 | 2 | 3 | 4  NEXT 

Read more:

Sign-up for our Start-up Newsletter

Email Address: