Tag Archives: Private Equity

Raising Capital? Prepare for Your Needs Well in Advance

Raising capital can be time consuming and expensive.  Capital may be in the form of a loan or an investment.  The lender/investor will seek a return on the capital in the form of interest, royalties, dividends, and/or capital gain.  Different forms of capital require different degrees of investment in time, due diligence, and closing costs.  The spectrum, as measured by ease and timeliness of closing, ranges from a bank secured term loan, being relatively quick and easy, to a minority or majority equity investment which can be complex and arduous to complete. Simply put, low risk capital is cheap and fast, and high risk capital is expensive and time consuming.

A secured loan can close about as quickly as the proper documentation and legal searches can be completed.  This usually takes several weeks.  An unsecured financing requires an assessment of equity risk which, if the issuer is not properly prepared, can take many months and, in a worst case scenario, unforeseen issues can derail the process entirely.

Preparation
An unsecured, or equity based financing is best approached in a prepared manner.  Even if only 10% of the equity is being sold, the steps in the process are similar to those of selling the entire business.  This includes writing a comprehensive business plan with a detailed use funds. Amount sought and use of funds are critical and, if the capital is for an acquisition then the investor may want to do due diligence on both companies and time the transactions to close at the same time.  The amount should be enough to fund the plan plus a cushion to reduce risk.

Owner-entrepreneurs tend to under-estimate the difficulty of raising capital.  Not being properly prepared can result in anticipated interest fading, a more expensive deal or, worst case, no deal at all.

Timeframe
If the required information is readily available, the preparation phase can be completed in about one month.  Securing investor interest will take another month, investor presentations another month, negotiating an LOI and closing another 60-90 days.  So six months, best case scenario.  While technically the process can move faster, practically speaking, taking busy schedules into account, this is realistic.  If the financial statements are not audited,  then a quality of earnings review can add another 6 weeks to the process.

Cost
For a secured loan, pricing factors include: credit quality of the borrower, the bank’s cost of funds and the level of competition in the marketplace.  As an example, if the bank’s cost of funds is 3% and the credit quality of the borrower warrants a 300 basis point premium, the bank would charge an interest rate of 6%.  On the equity side, the cost of funds is much higher and to meet target returns, investors have to compensate for the fact that not all investments will turn out as planned.  Equity investors target returns of 2-3 times their original investment at the end of a 5 to 7 year holding period.  A “triple” in six years is the equivalent of 20% return per annum.

Hiring an Advisor
Raising capital is generally not normal course business.  Therefore, hiring external resources to manage the process can be an ideal solution to these ad-hoc circumstances.  While the cost of an advisor typically represents a few points of the equity raised, it may well be that this would otherwise have been given up by going it alone anyway.  The intangible benefits of finding the right partner that is a cultural fit and has sector relationships to help grow the business are immeasurable.  The benefits of outsourcing management of the capital raising process to an advisor include:

I           Experienced strategic positioning and the preparation of a comprehensive CIM
II          Identification and engagement of the most suitable potential investors
III         Professional assistance in the preparation for presentations and due diligence
IV         Timely management of the process and securing the best price
V          The strongest chance of closing

If raising capital is critical to your business’s success, then don’t take any chances.  Start six to nine months in advance, assemble the best team and follow a process for success.

Have Your Cake and Eat it Too: A PE Case Study

Many owner-entrepreneurs are cautious about exploring the benefits and opportunities Private Equity (“PE”) can bring to a growing business.  To summarize some general characteristics, PE investments are typically:

–       Control positions ranging from 51% to 100% equity
–       Held for five to seven years
–       Part of a strategy to grow a strong competitive position in a certain sector
–       Will eventually need to be sold again; possibly to another PE

PE investments may be platform investments or add-on/tuck-in acquisitions.  In a platform investment, the buyer is looking for a market leader that it can use as a platform for growth.  Subsequent acquisitions or “add-on” investments will be one way to achieve this growth.  There is more risk in a platform investment because it comes with the challenges of learning a new sector landscape and the target company’s competitive position in it.  When considering add-on investments the PE is effectively acting as a deep pocketed strategic buyer and looks to exploit potential synergies between the buyer and the target.  Add-on investments are also called “tuck-in” or “tuck-under” investments because they tend to be smaller than the platform investment.

The following is a blind illustration of a recent transaction.  Jim founded his business, Innovative Technologies in 2000 and grew revenues to more than $15 million by the end of 2013.  Based in central Ontario, Innovative Technologies (“IT”) is an industry leader in the engineering, design and manufacture of custom bearings for the automotive industry.  Its customer base includes some of the world’s leading automotive OEMs.

In his mid-forties, Jim wasn’t looking to sell his business but realised he had a passion for product development and engineering and felt he was missing opportunities to grow the business.  Jim partnered with an investee company of a leading PE company, Loder  Manufacturing (“LM”) which makes complementary precision-engineered parts.  By combining the companies, the larger sales force of LM gained a complimentary product line to sell to its customer base.

Jim sold a controlling position in IT but continues to lead his business as an independent division within LM.  In speaking to his rationale Jim noted: “We ultimately decided to partner with LM as they share our vision for growing IT and can provide the financial, professional and operating resources required to accomplish our goals and provide our customers with the best bearing products in the world”. “I am also excited to be a shareholder in LM, and I look forward to helping LM accomplish its goal of building a first class manufacturing company.”

Private Equity can be an excellent partner for a company where a combination of capital and smarts can reinvigorate revenue growth.  In this example Jim diversified his net worth by partially cashing out, but retains a minority position in the combined entity which is a bigger, more diversified, stronger company that will be monetized in the next five years or so; effectively having his cake and eating too.