By: Paolo De Jesus
So you just started this new business and it’s really starting to take-off. You want to take it to the next level. BUT, you don’t have enough cash and you’re not sure how to raise more. You may have read about ‘private equity’ financing. You also may have no idea what that is. So what do you do?
Beware of the sharks! As seen on the television show Shark Tank, private equity is one way to fund your business by offering part of your ownership to investors. Whether you’re a start-up or a struggling company, private equity may be a good option to grow your business. It may seem pretty straight-forward, but there are several things you should consider before jumping into the tank.
First, the good news:
MONEY – had to emphasize this point! It’s the main reason you would be willing to give up some ownership of your company. Private equity investors are generally wealthy people or firms that have access to a steady stream of funds. Finding the right investor to believe in your vision could mean you will never be short on cash.
Don’t expect to be an overnight sensation. Your investors certainly don’t. They understand the risks of funding a budding business or a drowning organization. Initially, your company probably won’t outperform the market every quarter, but the hope is that it eventually will. These relationships are long-term; often the investors lose money in the early stages and make it back over a longer period.
Experience and Active Involvement
Some are handsy. Investors don’t take a passive role, but instead use a more hands-on approach. Generally, these people know the ins and outs of your industry and might open new opportunities. They will help re-evaluate every aspect of your company to see how you can maximize its value. Remember, that’s their goal.
They have a lot of ‘skin in the game,’ meaning they’ve got a lot to lose. They’ve invested a large amount of money in your company, and they want to make sure their investment pans out. They won’t profit unless your business is successful. So, of course, these investors aren’t just going to hand over the cash blindly. They are going to make sure you use it in the best possible way.
Now, the flip-side:
Loss of Ownership Stake
They give a lot, they take a lot. This is probably the biggest issue with private equity financing. With other funding options, the cash comes at a cost (e.g., interest payments on a loan), but you still maintain control of your company. Not in this case. Private equity tends to give out more money than other financing resources, but it also requires you to give up a larger share of your business. Most firms frequently demand a majority share in your company, leaving you with relatively little ownership.
Of course your portion can be negotiated. Having a seasoned attorney speak on your behalf would be ideal during this stage. It’s easier to have someone else explain your value and the reasons you should keep a larger percentage of your business, rather than hyping yourself up to investors on your own.
Loss of Management Control
Large amounts of money come with strings attached. You may lose control of your business. Again, investors often want to be actively involved in shaping the direction of your company. Often, this can be a good thing. But it can also mean losing your power in some areas, like strategy and staffing. Not everyone is on the same page at all times, and if there’s a disagreement between you and a major investor, there’s a good chance you’ll get out-voted.
Some of this can be avoided if it’s clear to everyone what their role is and what decisions they can make. Get this in writing! A solid contract can help to keep everyone in their lane so no toes get stepped on.
An investor’s primary goal is to make a profit. Private equity firms invest in companies to make them more valuable, make a return on their investment and sell their stakes for big bucks. In general, this is good for business owners. However, sometimes definitions of “value” differ. Often, an investor’s definition is limited to financial success. Yet, you may define value more broadly by considering non-financial aspects like relationships with employees, customers, and reputation. These things may not be as high on an investor’s priority list.
In the end, having an experienced team providing a steady stream of knowledge and cash might be a no-brainer. Just be aware of what you’re giving up in return. Remember, sharks can bite.
|Paolo De Jesus
Graduate Law Clerk