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Investment Process

The investment process, from reviewing the business plan to actually investing in a proposition, can take a private equity firm anything from one month to one year but typically it takes between three and six months. There are always exceptions to the rule and deals can be done in extremely short time frames. Much depends on the quality of information provided and made available to the private equity firm.

When you have fully prepared the business plan and received input from your professional adviser, the next step is to arrange for it to be reviewed by a few private equity firm. For the initial approach, it is worth considering sending only a copy of the Executive Summary to potential investors. This has the advantage of saving costs and increasing the chances of receiving attention.

All reputable private equity firms will respect confidential information supplied to them by companies looking for private equity capital. However, if you are particularly concerned about confidentiality, we would recommend that you ask for a confidentiality letter but only when the potential investor has received your Executive Summary and has shown an interest in giving your proposal detailed consideration.

Generally you should receive an initial indication from the private equity firms that received your business plan within a week or so. This will either be a prompt “no”, a request for further information, or a request for a meeting.

If a private equity firm is interested in proceeding further, you will need to ensure that the key members of the management team are able to present the business plan convincingly and demonstrate a thorough knowledge and understanding of all aspects of the business, its market, operation and prospects.

Assuming a satisfactory outcome of the meeting and further enquiries, the private equity firm will commence discussions regarding the terms of the deal with you.

The first step will be to establish the value of your business. There is no right or wrong way of valuing a business. There are several ways in which it can be done, two of which are:

  • Calculate the value of the company in comparison with the values of similar companies quoted on the stock market. The key to this calculation is to establish an appropriate price/earnings (P/E) ratio for your company. The P/E ratio is the multiple of profits after tax attributed to a company to establish its capital value, and are calculated by dividing the current share price by historic post-tax earnings per share. P/E ratios will vary according to industry sector (its popularity and prospects), company size, investors’ sentiments towards it, its management and its prospects etc.
  • Calculate a value for your company that will give the private equity firms their required rate of return over the period they anticipate being shareholders. Private equity firms usually think in terms of a target overall return from their investments. Generally “return” refers to the annual internal rate of return (IRR), and is calculated over the life of the investment. The overall return takes into account capital redemptions, possible capital gains (through a total “exit” or sale of shares), and income through fees and dividends. The returns required will depend on the perceived risk of the investment – the higher the risk, the higher the return that will be sought – and it will vary considerably according to the sector and stage of the business. Calculated IRRs could be anything from 20% up to as much as 70% per annum.

You and your team must have already invested, or be prepared to invest, some of your own capital in your company to demonstrate a personal financial commitment to the venture. After all, why should a private equity firm risk its money, and its investors’, if you are not prepared to risk your own! The proportion of money you and your team should invest depends on what is seen to be “material” to you, which is very subjective. This could mean re-mortgaging your house, for example.

If you use advisers experienced in the private equity field, they will help you to negotiate the terms of the equity deal. You must be prepared to give up a realistic portion of the equity in your business if you want to secure the financing. Whatever percentage of the shares you sell, the day-to-day operations will remain the responsibility of you and your management team. The level of a private equity firm’s involvement with your company depends on the general style of the firm and on what you have agreed with them.

There are various ways in which the deal can be financed and these are open to negotiation. The private equity firm will put forward a proposed structure for consideration by you and your advisers that will be tailored to meet the company’s needs. The private equity firm may also offer to provide more finance than just pure equity capital, such as debt or mezzanine finance. In any case, should additional capital be required, with private equity on board other forms of finance are often easier to raise. The structure proposed may include a package of some or all of the following elements.

By discussing a mixture of the above forms of finance, a deal acceptable to both management and the private equity firm can usually be negotiated.

As a next step, the private equity firm will send you an Offer Letter, which sets out the general terms of the proposal, subject to the outcome of the due diligence process and other enquiries and the conclusion of the negotiations.

To support an initial positive assessment of your business proposition, the private equity firm will want to assess the technical and financial feasibility in detail. External consultants are often used to assess market prospects and the technical feasibility of the proposition, unless the private equity firm has the appropriately qualified people in-house. Chartered accountants are often called on to do much of the due diligence, such as to report on the financial projections and other financial aspects of the plan. These reports often follow a detailed study, or a one or two day overview may be all that is required by the private equity firm.

If the private equity firm commissions external advisers, it usually means that they are seriously considering investing in your business. The due diligence process is used to sift out any skeletons or fundamental problems that may exist. Make the process easier (and therefore less costly) for you and the private equity firm by not keeping back any information of which you think they should be aware in arriving at a decision. In any event, you will have to warrant this in due course.

Finally, once the due diligence is complete, the terms of the deal can be finally negotiated and, once agreed by all parties, the lawyers will draw up the main agreement and then the legally binding completion documents. Management should ensure that they both take legal advice and have a firm grasp themselves of all the legalities within the documents.