Private equity investors aren't always the most obvious source of funding for startups and small businesses. But they're an increasingly important one, especially for entrepreneurs looking to scale beyond the startup phase. There comes a time when you need cash to grow--for new equipment, more inventory, and other resources to meet increased customer demand--and private equity has some of the deepest pockets.
Just ask serial entrepreneur John Bodrozic, co-founder of home-maintenance software company HomeZada. In 2000, his previous startup, Meridian Systems, which manages construction projects, sold a 30 percent stake to equity investor Summit Partners.
"When we took the money, we said, 'OK, we've got a good, growing business here, but let's scale this out in multiple directions,' " he recalls. "Private equity is going to look at your business from different perspectives than you do, which can actually increase its size and opportunity."
Bodrozic spent six years working with Summit, which eventually helped sell Meridian, before going on to co-found HomeZada in 2011. And he credits the investors for teaching him a lot about running his new company, including how to structure his sales team and how to expand his research and development department.
Still, private equity isn't for everyone, especially if your goal is to build a long-term independent business; most significant investments lead to an eventual outright sale (or public offering). But even if you don't want to follow that path, you can learn a lot from what this sort of outside financing can accomplish.
Scrutinize Every Partnership
Even the ones that seem to work.
In 2009, Castanea Partners purchased cosmetics company Urban Decay. Chief creative officer Wende Zomnir, who started Urban Decay with Cisco Systems co-founder Sandy Lerner, says the private equity firm "understands brands and luxury retail."
But not all of Urban Decay's partners have understood luxury retail so well. The company, based in Newport Beach, California, was having problems with some distribution abroad: Its makeup was sold by three British retailers, with 70 percent of sales at Boots, but Urban Decay CEO Tim Warner wasn't happy with how the drugstore was displaying the products. "It wasn't where we were taking the brand, and I didn't find it terribly innovative," he says.
He wanted to rethink the partnership--and Castanea agreed. Urban Decay pulled its line from Boots, and focused on its other two--much more upscale--U.K. retailers, department stores Debenhams and House of Fraser.
"Castanea said, 'We all know this is a risk, but we're going to be behind you,' " recalls Warner. "That was probably one of the most empowering moments of my career."
The bet paid off: Urban Decay expanded its business in the U.K., and boosted its overall revenue from $42 million in 2008 to $103 million in 2011. Castanea sold the company to L'Oréal that year--making eight times its initial investment.
Dare to Question Everything
Bucking consensus has risks--and rewards.
In 2010, co-founder and CEO Neil Grimmer sold a majority stake in baby-food company Plum Organics to private equity firm Catterton. Plum also sold food for older children, but only through a joint venture with Revolution Foods, in a line that used the Revolution name.
Industry consensus at the time was that you couldn't sell food for infants and for 10-year-olds under the same brand name: "No significant baby brand had ever successfully extended beyond the toddler market," says Jon Owsley, a partner at Catterton.
So Catterton took what Grimmer calls "a total leap of faith." It ended the Revolution venture, and rebranded the product line for older children as Plum Kids, betting that parents who knew Plum from their children's early days would stick with a familiar brand as their babies grew up.
That bet worked: Plum's revenue went from $4.5 million in 2009 to more than $81 million in 2012. The following year, Catterton sold Plum to the Campbell Soup Company. Though Grimmer sold his minority stake to Campbell, he continues to work as Plum's CEO.
Shrink to Grow
Ditch what holds your business back.
In 2008, Catterton invested in Restoration Hardware, a home-furnishings retailer that was struggling to grow profitably in the face of mounting competition from the likes of Pottery Barn and West Elm. Founded in 1980 by Stephen Gordon, who left the company in 2005, Restoration was a public company until Catterton took it private.
The firm spent the next four years shutting down Restoration Hardware stores, shrinking the company's retail footprint from 110 locations to just over 80, abandoning smaller, mall-based outlets. Instead, it focused on what managing partner Michael Chu calls "gallery stores," which are larger, multistory spaces that emphasize the airy, aspirational lifestyle Restoration Hardware customers buy into as they shop for its tastefully minimalist couches and throw pillows.
The shrinkage and refocusing helped double revenue, and Catterton took the company public again in 2012.
Breaking Down the Buyout Numbers
Why are more businesses selling stakes to private equity firms every year?
6,756 vs. 7,779
The number of PE-backed U.S. companies rose 15 percent from 2010 to 2014, according to research firm PitchBook
The average holding period of PE-backed companies in 2014 increased from 5.5 years in 2011, according to data company Preqin.
4.5% vs. 6.2%
2014 job growth in middle-market companies without PE backing trailed that in PE-backed ones, according to the National Center for the Middle Market.
The total value of U.S. PE deals in 2014 was up more than 34 percent from 2010, when investment activity was still recovering from the economic crisis, according to PitchBook.
6.6% vs. 8.5%
Revenue grew more slowly in 2014 at middle-market companies lacking PE backing, according to NCMM.