Why firms should tap private equity for funds

By Odhiambo Ocholla

Jeff, an entrepreneur, knew there was a market for his product and used his own funds to acquire a company from his former employer.

He had approached local banks for money to launch his business expansion initiative, but nobody was willing to listen because banks will not accept such risks.

Banks want everything perfectly guaranteed. Jeff’s case is a typical scenario facing many entrepreneurs who want to buyout a firm.

When help is not forthcoming from mainstreams commercial banks it is better to turn to private equity investors— an increasingly popular source of funding for small business.

While private equity investment is expected to grow in the coming years, the current credit squeeze may impact on their ability to tap the credit they need to fund their acquisitions.

In recent years, ours has been a tough market for private equity, with too few deals, a booming stock market then causing sky-high valuations and regulatory hurdles hindering investment in certain sectors.

Growth in private equity

The surge in private equity funds in Kenya would be supported by three pillars.

The continued optimism and growth of middle-class in spite of inflation and the economic downturn, the tightening of credit from commercial banks and the decline of our stock market.

Investments in companies that target our emerging strong middle class will continue to pay dividends for private equity funds going forward.

The declining stock market and the ongoing credit squeeze create a great opportunity for private equity firms to provide capital and get more reasonable valuations from fast-growing companies than has been possible in the last few years.

We have smaller players in the private equity business who are willing to work with small and medium-sized businesses. They certainly have the money.

Private equity firms pool capital from wealthy individuals and institutions, such as insurance companies, pension funds and commercial banks.

The firms then look for companies to invest in. Most seek established, profitable firms with proven management teams.

Private equity deals include leveraged buyouts, where the firm buys a majority stake to give shareholders liquidity and growth investments.

The problem with private equity for many business owners has been loss of control or fear thereof.

But experts say, with so much money seeking deals today, sellers can get better terms. Investors have to get over this fear of loss of control.

There are even some private equity funds that buy a controlling interest and then generally leave the day-to-day operations to existing management.

It is not wise to buy out management teams that have made business successful; you would rather invest with them.

Ways to find the best deals

As investors, it is advisable to network with other business owners to identify appropriate investment firms.

Look for more than one option because your negotiating power increases when several firms are interested.

Target potential investors precisely, by researching private equity firms.

When shopping for private equity fund, you need to provide a business plan, document financial results, and describe the management team and markets.

Try to look at your company from an outsider’s perspective to anticipate the tough questions from private equity investors. An investor will eventually find out the strengths and weaknesses of the business.

Consider cultural fit

Finding the right match often comes down to style and values. Further, when shopping for private equity funding consider the worst-case scenario.

Not all deals succeed.

Evaluate how you might feel about the financial partner if times get tough. Finally, before you get serious about going into a private equity deal, think about how to get out.

Such deals generally conclude when a company is sold to another firm, often a larger player in the same industry.

Or a company can be sold to a larger private equity firm that can provide additional capital and liquidity to shareholders or sometimes, the company goes public.

Occasionally, a private equity firm will exit by selling its stake to the founder or current management through recapitalisation.

—The writer ([email protected]) is an Investment Banker.