Posted on: November 25th, 2019
Private equity gets a bad rap at times for its ruthless efficiency in generating returns. The industry has evolved greatly from mere financial engineering to encompass a broad range of business building expertise. It is no longer enough to buy a company at a high multiple, pay down debt, and grow revenue moderately. Today’s private equity deals have ambitious growth plans baked into them from the outset. They involve various strategic maneuvers that accomplish three central objectives: distribution expansion, product line expansion and regional expansion. Overlaying these objectives is a 3 to 5-year time horizon that imposes timing discipline on the investment thesis. Although it may be safer and sounder to carry out a step change function in growth over a 10-year time period, the private equity industry does not have the luxury of Warren Buffet-like hold periods. This makes acquisitions the preferred route and the systematization of scaling mandatory. In some cases, Private equity firms pursue large and small acquisitions simultaneously. The large deals are game changers and take the company in a new direction where the small acquisitions are a form of large ticket organic growth.
It’s a sensible approach given the shortness of time and the need to stimulate faster rates of growth. The alternative, hiring more salespeople, can be a long slog and can have less than certain outcomes. At least with an acquisition, you acquire instant revenue with a live book of accounts. Fast scale-ups are the way to go especially given the targeted rate of returns of mid to high teens for the industry. When you buy a company at 8 times EBITDA and must achieve a 15% rate of return on your equity investment every year for 5 years to be average, you must move quickly and be bold. From this economic reality, best use cases for private equity have emerged in the market. Most companies rule out private equity because they don’t have a handle on how it can work for them. But it pays to understand the best uses for private equity, as it allows you to do creative and strategic things that are not possible through your own financial resources. Here are the best uses for Private Equity:
- Strategic Transformation – If you have bold plans that involve multiple mergers and innovation strategies, private equity can be a supportive partner.
- Sale or Exit of your Company – Private Equity is a great option to monetize your exit value. Most of their deals are succession driven where the owner is exiting.
- Strategic Roll-up – If you are a platform company seeking capital and acquisition targets, private equity is a strong option. They can help bring deal flow and financing clout to your process.
- Growth Equity- Fast growing technology companies can tap Private Equity firms for growth equity to ensure they have capital to support fast growth. Growth Equity providers give good valuations and are very supportive partners.
- Management team acquisitions– Proven independent management teams can partner with private equity firms to purchase companies and implement exciting growth plans.