Not All Private Equity Is the Same
A spate of record-breaking private equity deals has recently topped the news headlines. Unlike the growth equity transactions that small-to-midsize business owners may be considering, however, these transactions are heavily leveraged buyouts. The reality is: Not all private equity is the same. That's why business owners must understand the important factors that differentiate firms specializing in growth capital from those engaging in heavily leveraged buyouts.
Over the years, my firm has worked with hundreds of growing companies, providing capital and strategic guidance to help them reach their potential. In fact, 50 of our portfolio companies have been recognized on the Inc. 500 list of the fastest-growing companies in North America. The operative term here is "growth." Growth-oriented investors employ an investment strategy that differs from the one used by mega-buyout firms. Here are some key distinctions:
Willingness to make minority investments: Many of the large transactions you read about in the news are "control transactions" -- the investor purchases a majority of a company in exchange for voting control and control of that company's board. Growth equity investors, on the other hand, are willing to make either majority or minority ownership investments. These investors do not require control because they are backing companies they believe in -- companies with a solid history of growth, a capable management team, and the potential for future expansion. When a growth equity firm identifies attractive companies, it provides them with the capital needed to fund company-related initiatives. Some firms also provide investors or founders with personal liquidity.
Entrepreneurial control of the business: In a growth equity investment, the entrepreneur typically continues to run the company. Growth-oriented investors recognize that successful entrepreneurs not only are used to calling the shots, but also know more about the company's products or markets than any investor could. That's why these investors want the management team to continue making operating decisions.
Growth-oriented investors do add value, however. Drawing on their experiences with hundreds of growing businesses, they offer broader perspectives on the challenges confronting a growth company. Moreover, they can advise on financial issues, such as when and how to seek additional liquidity, evaluate acquisition candidates, and start working toward a public offering or acquisition.
Although these investors offer guidance, a network of contacts, and specialized expertise, they want the entrepreneurs they back to run their companies. Many growth equity investors believe in this philosophy so strongly that they follow it even when making a majority investment.
Leverage: Mega-buyouts are heavily leveraged, with double-digit debt to EBITDA ratios in many recent instances. This makes sense when you are investing in slow-growing, cash-generating businesses, where financial engineering can significantly boost returns. However, fast-growing companies can typically generate superior returns without leverage. In fact, these companies may prefer not to borrow, knowing that making substantial interest and principle payments may constrain their ability to invest in the business. As a result, most growth private equity investments are either all-equity or equity with modest amounts of leverage.
Flexible investment size: Although recent media attention has focused on multibillion-dollar deals, these transactions only represent a portion of the total private equity universe. Private equity deals may range in size from a few million dollars all the way up into the billions of dollars. Different firms emphasize various areas of the market: venture capital firms provide capital to startups, growth private equity firms focus on more established companies with strong prospects for future expansion, while buyout firms concentrate on larger, slower growing companies.
Continuity: In the large buyout transactions, new owners sometimes try to rationalize a business and cut costs by instituting layoffs, plant closings, and benefit program overhauls. That differs greatly from the typical growth equity investment, where the management team, employees, facilities, and business operations typically remain much the same. If anything, companies that receive growth investment tend to grow bigger, expand their operations, open new locations in new geographies, and hire more employees.
If you are a business owner, you may be concerned with the recent media coverage of private equity transactions. Still, it is important to remember that these deals represent only a segment of the private equity industry -- and that they differ greatly from the type of growth-oriented private equity transaction that you and your company may be considering. Because not all private equity is the same, business owners need to understand the differences among firms specializing in venture capital, growth financing, and leveraged buyouts. Knowing your options and choosing the right kind of private equity financing can be critical in achieving your company's long-term goals.
Bruce R. Evans is a managing partner of Summit Partners, a private equity and venture capital firm with offices in Boston, Palo Alto, and London. Since 1984, Summit Partners has invested in more than 290 growing, profitable companies across the United States and Europe. Bruce can be reached at 617-824-1000 or firstname.lastname@example.org