Private Equity: Taking Companies to the Next Level

The number of mergers and acquisitions has continued to be strong in recent years, and private equity has remained as one of the driving forces.

With private equity capital looking for investments these days, the gates may be open for companies to find opportunities for cash infusions while business owners remain at the helm.

At some point in their business cycles, midsized companies often find they lack the financial resources or management skills to cut overhead and spark growth. In such instances, private equity investors might be able to help.

Rather than investing in companies that they possibly break up and sell off, many private equity firms take another tack. They work with existing management to enhance shareholder value by finding profit solutions, including plant and equipment upgrades, new product development and process improvements that shorten lead times.

In these transactions, a private equity group targets businesses with strong track records to add to its portfolio of companies. Some private equity investors specialize in certain industries. The terms of the deal depend on fundamentals such as the company's financial position, management team, business plan, growth strategy, customer base and objectives for the capital infusion.

Often, private equity investors turn to outside professionals, including accountants and attorneys, to provide due diligence, tax advice, business consulting and other services for their portfolio companies, as well as businesses they are interested in acquiring. (See below for a list of ongoing services that accounting firms may offer in private equity transactions.)

In addition to providing expertise, some private equity investors operate a purchasing group, which allows their portfolio companies to buy certain goods and services at lower prices than they can obtain themselves.

Retaining Some Control

If the existing business owners hope to retain management after the transaction closes, they must consider the private equity group's horizon for involvement. Generally, a private equity firm's stays engaged for three to seven years, after which it expects a solid return on its investment. The investor's exit plan and ideas should match the vision of existing management. A private equity deal can eventually result in a third-party acquisition, a management buyout, an initial public offering or other exit strategy.

The level of a private equity firm's financial and operational contributions — and a factor business owners must closely evaluate — often depends on the approach investors plan to take: hands-on or hands-off.

With a hands-on, active approach, the goal is to become a business partner. Although day-to-day operational control isn't usually part of the deal, private equity firms expect to have a seat on their portfolio companies' boards. They may also want businesses to:

• Provide forward-looking managerial information, such as budgets, cash flow and sales goals, as well as copies of the minutes of board meetings.
• Be advised by outside professionals hired to help identify critical problems and opportunities — and take action to solve or take advantage of them.
• Allow consultation, involvement in, and veto power over major business decisions such as large capital purchases, changes in strategic direction, business acquisitions and disposals, debt levels and leadership.

In a hands-off, passive approach the investing firm basically allows management to run the business until the exit time. However, the firm still expects regular financial reports. And if a business fails to meet agreed targets, defaults on payments, or runs into other difficulties, the private equity investors typically become more involved.

In the end, private equity investment can help ensure some companies thrive. It can also offer employees and management a chance to share in the company's success through incentive-based programs that allow them to buy or earn equity.