If you ask the average small business owner where to get a loan, most can easily provide a few answers right off the top of their head. After all, they probably have a bank account, so they might mention their bank and maybe remember where they went the last time they sought financing.
Now, if you ask these same business owners where to raise private equity for their company, they’re not so quick to answer. Most entrepreneurs, when asked where to find private equity, find their way to suggesting you check with a lawyer or accountant, and a handful may talk about a private equity investor they have met or who has approached them.
But the difference in answers is stark.
It can be like the tale of two ships in the night―small business owners seeking a new source of capital and private equity funds searching for companies where they can put their capital to work―often struggling to find each other.
I frequently hear from small business owners that they don’t know where to turn for capital or, more specifically, that their geography is underserved by capital providers. And this isn’t the only barrier for small companies—many private equity funds are interested in companies of only a certain size or industry and with certain cash flow profiles.
Private equity funds are attracted to companies they can understand, where they can add value (at the right price), and with a management team they can connect with. After that, private equity investors will of course put the highest priority on the transactions they think are best for their fund.
When small business owners approach us to raise capital, we try to familiarize them with the pros and cons of private equity.
- The upside: Access to capital beyond what a bank would traditionally finance, and perhaps the opportunity to pursue a long-sought-after growth or acquisition initiative that just needed the ready cash to finance.
- The downside: Private equity is expensive. Funding from a bank in almost any stage of an economic or credit cycle is always cheaper.
The biggest cost, though, isn’t necessary financial—it’s in allowing someone else into your business as a partner. Small business owners frequently don’t appreciate how uninvolved their lenders are in their business. Sure, the lender needs regular statements, regular payments and abidance with covenants, but he or she really isn’t involved in the day-to-day operations of your company. A private equity investor, on the other hand, takes a different tack. The investors will create a board (or take a board seat if you already have a board), set strategy, map out guidelines for future capital infusions, and draft a compensation structure, among other things.
We coach entrepreneurs to think about the upside of these deals, but also to take a close look at themselves to decide if they really can deal with someone being that involved in their business. For many operators this is easy. They may already be reporting to an owner, a partner or perhaps a family member. For others, this is a huge structural change, especially if they created the company or have run it on their own.
Private equity funds want entrepreneurs who will be good partners. Will the entrepreneur take advice? Does her or she listen? Does the entrepreneur take in ideas and feedback, and then come up with better answers? Frequently, private equity funds get some comfort by buying into companies that have been backed by other private equity investors—management already has the experience of living in this environment.
The key to a good match with a private equity investor is preparation. You can’t wait until you are in need of a major investment to start this process. We recommend that companies build the bridge to a transaction long before they have any need to cross it.
Ask your lender, attorney or accountant if they know any private equity funds in your geography or that invest in your industry. At your next networking event, seek out a private equity investor to find out what they look for, how they think about businesses and who is active in your area. Use this networking time to practice your story (your “pitch”) with these potential investors. And in return, ask them how a private equity investor would think about your company.
You may just learn now what you might need later.