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MONEY

How to Pick the Perfect Investor

Choosing an investor to help fund your company is like choosing a spouse, only more complicated. Here's how to know you've found The One.
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David Mahmood, the chairman of my investment banking firm, often compares choosing a financial investor to selecting a spouse. “Selling to a private-equity group is like getting married,” David likes to say. “When it’s good, it’s great; when it’s bad, it’s a pain in the ass.” 

Whether we’re talking love or money, which would you prefer? (Same here.) With that in mind, I thought I’d list four qualities that any private equity partnership (or for that matter, any marriage) needs if it is to succeed.

1. Chemistry

Sure, she’s pretty, but I can’t stand to talk to her for more than five minutes!

Let’s face it: You either have that “spark” or you don’t. In a business relationship, that means someone who shares your vision. Understand that this does not mean you want to find a clone of yourself; in fact, it’s best to find a partner who is quite unlike yourself and can contribute strengths that complement your own. The key is for both you and the investor to be on the same page regarding the ultimate goals for the company. Your partner needs to be just as enthusiastic as you are about the venture’s potential for success-;and the strategy you’ll be deploying to get there. A shared sense of values--the buyer’s principles and beliefs should be in alignment with your own--is the key to making a partnership work.

2. Understanding

But I thought you’d love a vacuum cleaner for your birthday!

A quality private equity group must have a fundamental grasp of your industry and your business model. If they start asking basic questions (for example, if you’re in the business of providing e-commerce services and a potential buyer needs you to explain data encryption), there may a problem. You don’t have time to educate your new majority partner, and you don’t want that partner pressing for strategies that simply don’t make sense for your business.

Don’t forget, though, that you know more about your company than anyone else on the planet. Be fair. Don’t expect the investor to be an instant expert on what you do. They just shouldn't be clueless.

3. Cash

I can’t believe he proposed before he could even afford a wedding ring!

It’s a bad sign when the buyer wants to structure the transaction in a way that puts the seller at more risk than they are. When a private equity group buys your company, they invest some of their own capital (equity), and finance the rest of the transaction by borrowing from a bank. That debt goes on your company’s balance sheet. During the M&A heyday of the mid-2000s, some transactions were leveraged at a ratio of 10 dollars of debt for each dollar of equity.  As a rule of thumb, in today’s markets, you shouldn’t look at a deal proposing more than 50 percent debt financing.

A financial buyer should also have a committed fund with committed money.  Private equity groups raise money from institutional investors (mutual funds, pension funds, and like) that goes into a committed fund that the group owns and manages. By contrast, some potential investors don’t have a fund; instead they say they have relationships with people who are willing to put money behind their deals.  In other words, if they find a deal, they have to go back to their “investors” and convince them to put money into the transaction. That’s not the kind of partner you want.

4. Commitment

If you don’t commit to a wedding date right now, I’m calling the whole thing off! 

Deals that drag seldom close. If the private equity group isn’t pressing forward during the deal, it is not likely to be proactive and committed after the sale, either. Maybe the investors are dragging out due diligence, or being slow to respond during negotiations, or vacillating on the terms of the deal. If they can’t be bothered to actively pursue you during the deal, how much do they really want you in the first place? Certainly, there can be bumps in the road that slow down the process--a dip in company performance, for example, almost always delays a deal and can lead to a renegotiation of terms--but in general the buyer should want the same thing as you: getting the deal done as quickly and painlessly as possible.

 

Last updated: Jun 18, 2012

DAVID LONSDALE | President, Allegiance Capital

David Lonsdale built and sold three venture-funded companies before becoming president and co-owner of Allegiance Capital in 2005, which provides M&A financial services to middle market business owners.




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