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Private Equity Investing – Setting the record straight

By : Ziad K. Abdelnour| 29 June 2010
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We at Blackhawk meet on the average over 500 entrepreneurs a year; and the question that keeps recurring at all times by every one of our entrepreneurs seeking funding is: Why is every private equity fund we meet trying to take advantage of us? We are much more comfortable in dealing with family offices such as Blackhawk; could you please help us?

Our view in this regard is very simple:

As venture capital and private equity continue to make news headlines, entrepreneurs may find it challenging to distinguish fact from fiction.

1. Do investors win at the expense of entrepreneurs?
2. Are investors out to wrest control from management?
3. Is an investor’s sole focus on the final liquidity event?

Without question, misperceptions can prevent an entrepreneur from making rational, fact-based decisions.

During my 20 years as an investor, I have come to identify what I call “The Five Myths of Private Equity.” Let’s closely examine these five myths, one by one:

Myth #1: Private equity is a win-lose game — investors win, entrepreneurs lose.

According to this myth, private investors somehow make off with the value of your company — perhaps buying at a too-low price and cutting you out of the eventual rewards that you’d earn from going public or selling to another company. Remember, though, that private equity investors only make money if the value of your company appreciates — and, in most cases, the entrepreneur retains a substantial interest in the business. After all, it’s in their best interest to help you grow your company and increase its value. Almost by definition, if the investor wins, the entrepreneur wins.

Moreover, a private equity investment provides entrepreneurs with the opportunity to diversify their assets. You receive cash for part of your share in the company, which you can spend or invest as you see fit. As a result, you immediately reduce your exposure to events at a single company, in a single industry — and can access cash that you may need for retirement, college tuition, or major purchases.

Myth #2: Valuations are the only consideration when you’re shopping the deal.

Valuation is certainly an important consideration since you want to get a fair price when you sell your company. However, it’s equally important to partner with an investor who shares your goals and who will work with you to achieve them. When you focus exclusively on valuation, you risk ending up with a partner who doesn’t understand your company, your growth strategies, or your industry.

Let’s say, for example, that you sell your company to an investor whose expectations for your business are unrealistically high. You may obtain a good price for your company, but that relationship is likely to sour as the business fails to meet the investor’s expectations. On the other hand, an investor with a more nuanced understanding of your company would work with you to increase its value in a realistic and sustainable way.

Myth #3: Private equity investors don’t add value because they haven’t been in an operating role.

Most entrepreneurs have ample experience with operating issues. In fact, that’s one of the main reasons private equity investors should not try to micromanage portfolio companies. However, they can add value by challenging management to think outside the box.

Investors who have backed many different companies at rapid growth stages can recognize patterns that may not be obvious to the management team. They may have a network of relationships that can also assist companies in recruiting talent at the board and management level. They can often help companies explore strategic partnerships with other firms.

Myth #4: Taking venture capital/private equity money means you lose control of your company.

If you take on a minority investment, you can continue to control your company — making all operating decisions and having the ultimate say over strategic issues. Selling less than half of your company leaves you in charge, while providing liquidity to you and other early shareholders.

Myth #5: Private equity investors are only interested in your exit strategy.

When a private equity firm invests in your company, they do expect to exit their investment within the next five to seven years. Since the firm has limited partners who expect liquidity at some point, they can’t hold their investment forever. However, this doesn’t mean that your company will have to sell your company or take it public. Alternatives might include recapping the company with bank debt, swapping out one investor with a new private equity investor, or raising capital from a strategic partner.

In any event, your private equity partner has a vested interest in growing your company over the next several years up to the exit event. Their goal during this period is the same as yours: to increase the value of your company by expanding the business.

Bottom Line:

Focus on what’s important, put the myths to rest

Whether to take on private equity investing is a complex decision, requiring in-depth analysis of your personal and business goals, the market environment, and the financing options available. Focusing on these important considerations — rather than on common misperceptions — will help you make the right decision. It’s time to put the myths to rest.

Looking forward to doing business with you and to continue being your resource for deals, capital, relationships and advice.

Your feedback as always is greatly appreciated.

Thanks much for your consideration.

Comments

  1. Pingback: Challenges & Opportunities we see when Investing in Rollups

  2. DianeBDianeB

    Fact #1: Private Equity is contributing to the acceleration of the trend towards ever-increasing concentration of wealth in fewer and fewer hands. Not that I am advocating that everyone should be “equal,” but let’s face it; in a consumer-driven economy you need consumers to keep your economic engine running. When it gets to the point where you have rendered enough of your consumers unable to buy much, you destroy your economy. Unfortunately, that is the “tipping point” we are now facing, and we have a choice; we can continue along this path to satisfy the unending greed of a select few at the expense of the economic health of our country, or we can stop the madness of supporting economic suicide in the name of our fantasies of becoming the “next multi-billionaire” and opt for some moderation in the name of preserving some stability in our society. I don’t know about anyone else, but in my book, no individual’s ambitions are worth sacrificing our society.

  3. Kumar SriramKumar Sriram

    I have a simple question. When does an enterpreneur look towards a private equity investor to fund his business? Is it as early as seed funding or sometime later? I like what you have said about the myths, and strongly believe in 2 things – also my mantra – usually helps in keeping ahead of the pack. 1. Make money for others. You will make money for yourself along the way. 2. Always think about ways to earn more revenue for the business.

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