When It's Time to Consider Private Equity
BY Joe Trustey
If you are like many business owners and management teams, you may reach a crossroads where taking on private equity capital makes sense.
Many of the world's most successful private companies bootstrap their way to success, relying on the founders' personal capital, hard work and acumen to build profitable businesses. Yet even these very self-sufficient businesses may eventually find that they need outside capital -- whether for the founders' increased personal financial security, to finance further growth, or to help prepare a company for a future IPO or sale.
If you are like many business owners and management teams, you may reach a crossroads where taking on capital makes sense. Here are three different real-life situations where business owners and management teams chose private equity to address either a business or personal objective.
When early shareholders want to diversify
Many people think about private equity solely in terms of company financing, yet it can also enhance entrepreneurs' personal financial security. That's because founders and early shareholders often hold much of their personal wealth in the company. As a result, they are wealthy on paper but don't necessarily have a diversified personal balance sheet or ready cash for large, personal expenditures. An infusion of private equity can allow founders, owners and early investors to take some of the rewards off the table, while reducing their investment risk through diversification.
Providing liquidity for early shareholders can also help entrepreneurs meet related business objectives. For example, back in 1998, one of my colleagues met with the management of Keystone RV Company, a manufacturer of recreation vehicles based in Goshen, Ind., and a two-time Inc. 500 company (2000, #2; 2001, #126). Keystone was, at the time, majority owned by a group of individual investors. The investors had provided cash at the company's start-up, but many of them wanted to exit their investment in Keystone and realize profits. At the same time, Keystone's CEO was looking for a way to provide ownership incentives to his team of key executives.
A private equity investment allowed Keystone to cash out early investors, while also establishing ownership stakes for the management team. By making managers shareholders and rewarding them for maximizing the company's value, Keystone was able to accelerate its growth rapidly after the investment. Keystone grew to become one of the leading companies in its industry and in 2001, the company was acquired by Thor Industries for more than $150 million.
When accelerated growth requires capital
You also may wish to use private equity capital as a way to accelerate your company's growth. Additional capital would allow you to take advantage of certain strategic opportunities that you simply don't have enough cash to pursue on your own.
For example, several years ago we met with Senior Home Care, a Florida-based fast-growing home healthcare company facing strong demand for its services. However, to meet that demand, the owner knew that he would have to make an investment.
It would take the owner both time and money to recruit more nurses in a very tight labor market and then to train them extensively. Once his new employees were in the field, it might take a month before his company could bill for services -- and up to three months before getting paid.
To the owner, however, the opportunity was clear. He knew that hiring more nurses would generate additional profits. By taking on a private equity partner, he was able to staff up, take on new customers, and realize additional revenues -- without losing control of his business. Though in this case, Senior Home Care's growth was internal, other companies may find that acquisitions represent their best path to growth, and private equity capital can help fund these strategies as well.
When you're preparing for sale or IPO
Finally, companies may consider taking on a private equity even if they don't need the money -- simply as a way of making the transition from a private to a public company. A private equity partner can generally help companies in a number of ways, including:
Upgrading the board of directors with seasoned industry professionals
Recruiting senior management, if necessary
Implementing more sophisticated systems and financial controls
Introducing entrepreneurs to investment bankers or potential buyers in preparation for an eventual IPO or sale
As David Kalt, CEO of optionsXpress, remembers it, cash was one of the last things that his company was looking for from a private equity partner. OptionsXpress, an online broker based in Chicago, Ill., specializes in the fast-growing market for online options trading for retail investors. The company expanded rapidly over the first three years of its existence, reaching 70,000 accounts and $50 million in revenue by the end of 2003. "Because we were very capital-efficient and profitable, we didn't need an outside investment to grow the business," said Kalt, "Instead, we viewed a private equity relationship as a way to navigate very rapid expansion and prepare for an IPO."
What helped get optionsXpress to the IPO stage? A $90 million equity investment provided liquidity to early shareholders, allowing the firm time to fully consider its IPO strategy. Additionally, its equity partner helped them understand the process and introduced the optionXpress executives to key players in public markets. It helped the company build a top-notch board and recruit an experience CFO who upgraded the company's financial systems and reporting to public market standards, further assisting the company in its IPO path. In January 2005, optionsXpress (Nasdaq: OXPS) completed a successful public offering.
There's no set timetable for seeking out private equity. Some companies operate perfectly successfully on their own for decades; others seek an infusion of capital earlier in their life cycle. Regardless of the exact timing, most successful entrepreneurs and management teams do eventually reach a stage where exponential growth is possible, and where they want to reap the financial rewards associated with the company they've built. When your company comes to this crossroads, you, like many other successful entrepreneurs, may wish to consider taking on a private equity partner.
Joe Trustey is a managing partner of Summit Partners, a private equity and venture capital firm with offices in Boston, Palo Alto, and London. Summit Partners invests in growing, profitable, privately held companies. E-mail Joe at email@example.com.