Anatomy of a Financing: A Pitch for Private Equity
John Cook, CEO of the Profit Recovery Group, a financial-services firm based in Atlanta, needed financing last year. His five-year-old company, which audits clients' accounts-payable records for overpayments and other costly errors, had grown from $5 million to $34 million in sales.
"We had tremendous growth prospects, but to sign up any more new business, I had to hire and train additional auditors and set up support networks in new locations," recalls Cook.
Wanting to delay an initial public offering until his company was bigger, Cook decided to raise money instead through the private-equity markets. "This type of financing can be a bridge to going public or an alternative to an IPO," explains Thomas Shattan, managing director of Prudential Securities' private-equity-financing group, in New York City. "Many business owners don't know about private equity, or they confuse it with venture capital. But it's really very different." Here's how:
· Deal size. "If a company needs to raise only $10 million, few underwriters would be interested in an IPO. But that's a perfect size for private equity," notes Shattan, who adds that deals typically range from $8 million to $25 million.
· Equity transfer. If a CEO is not willing to sell a controlling stake, venture capitalists might pass. "Private-equity investors typically invest in minority-interest positions," says Shattan. The stake might range between 10% and 30%. Investors include selected insurance companies and pension funds, high-net-worth individuals, and foreign investors. A handful of banks also invest.
· Deal structure. Private-equity deals usually get structured in the form of convertible preferred stock. Explains Shattan, "That converts to common stock at an IPO, but investors do not have the ability to force a public offering" -- which differs from many venture-capital arrangements.
Instead, securities usually include a so-called put option that allows investors to sell their stock back to the company at fair market value, beginning at the end of the fifth year. Most puts are timed to include a three-year payout schedule, "so that it's generally not until the end of the eighth year," says Shattan, "that business owners have to come up with all that cash."
Cook has no regrets about having chosen this financing route. "I raised $12.5 million and had to give up only 15% of my company and one board seat to do it," he says. As for growth? In 1995 "we went from $34 million to a projected $60 million," says Cook. "I know we'll be ready for a very profitable IPO at some point down the road."* * *