Finding Investors for Your Old-Economy Company
More often than you would expect, a manager of a private equity fund looking to raise capital tells us a story about a business that, in the words of the fund manager, does no marketing.
The fund manager describes the company, which is usually an old-economy company that produces something that businesses buy on a regular and repeated basis. The company takes orders instead of pushing for sales and often hasn’t changed its prices in years. Most of the employees are involved in the manufacturing of the product (or service), and sales are handled in "accounting" or by a small team that takes inbound calls from customers when they run out of the product. Sales are kept in a spreadsheet. Orders are filled and shipped. The company owner cares a lot about the employees and customers, and each year the company makes a small but healthy profit and continues to march on.
Making an Old-Economy Company "New"
The characteristics noted above are often what a lender looks for in a borrower and are also signs of untapped opportunity to a private equity fund. The stability and certainty of the company’s activities are attractive to a lender; the strong customer base combined with the potential to grow make the company attractive to the private equity fund. Let’s unpack them one by one:
No Marketing Spend
Companies that have limited sales or marketing expense have customers who drive revenue with limited expense in capturing that revenue. Existing customers call in orders. New customers cost money to identify and acquire. The cash flow or EBITDA margin on these type of companies is generally higher than those with sales forces. For a lender, that makes more cash available to pay back the loan.
Conversely, the low spend on sales and marketing could be a sign of an untapped opportunity for a private equity fund. The fund could invest in a sales force to capture revenue from a new geography or customers that the company never reached before. Private equity funds will figure out the return on investment of that sales force quickly.
Current customers who consistently buy on a regular and repeated basis make cash-flow predictions simpler and reduce the risk to the lender in extending credit. Repeat customers reinforce the need for a product; if someone keeps coming back for it, it must be essential to their process. For a private equity fund, that repeat customer allows it to use debt in its purchase of the company. The margins earned from repeat customers can fund the debt the company borrows.
Unchanged Price List
Lenders and private equity funds are often of the same mind on this point. A history of no price changes combined with customers coming back repeatedly usually implies the opportunity for a price increase. That price increase creates additional cash flow to pay off debt and fund the growth of the company for a private equity fund. No price changes also usually implies no hidden commodity price risk in a company, which is attractive to both a lender and a private equity investor.
Limited Enterprise Resource Planning (ERP)
ERP systems help a company see what it is doing across functional departments in a company. Running a business on spreadsheets means a company doesn’t even have an ERP system. A lender usually prefers the certainty of robust reporting that comes with an ERP system but will accept thorough quarterly financials along with annual audit from an accounting firm. A private equity fund looks at the ERP issue similar to the No Marketing Spend--it’s an opportunity to invest in the business, so better information is available to managers (and the private equity fund). That information usually drives efficiency and allows the company to manage growth better. Finally, via the new ERP system, the private equity fund will be able to provide better data and show the value of this investment to the next buyer.
Companies with these characteristics are often called "old economy." But they are attractive to financing providers, both because of the certainty of their cash flow and the untapped opportunity hidden inside them.
Find in your company what makes it attractive to a lender or a potential investor.
ED POWERS | Columnist | Head of Capital Access Funds, Bank of America
Based in New York, Ed Powers is a managing director and head of the Capital Access Funds team at Bank of America Merrill Lynch. Capital Access Funds is an experienced, returns-driven private equity fund-of-funds.