Advantages & Disadvantages
Private equity backed companies have been shown to grow faster than other types of companies.
This is made possible by the provision of a combination of capital and experienced personal input from private equity executives, which sets it apart from other forms of finance.
The main advantages of private equity over debt financing are:
- Medium to long-term investment horizon;
- Committed until “exit”;
- Provides a solid, flexible, capital base to meet your future growth and development plans;
- Good for cash flow, as capital repayment, dividend and interest costs (if relevant) are tailored to the company’s needs and to what it can afford;
- The returns to the private equity investor depend on the business’ growth and success. The more successful the company is, the better the returns all investors will receive;
- If the business fails, private equity investors will rank alongside other shareholders, after the banks and other lenders, and stand to lose their investment;
- If the business runs into difficulties, the private equity firm will work hard to ensure that the company is turned around; and
- A true business partner, sharing in your risks and rewards, with practical advice and expertise (as required) to assist your business success.
A provider of debt (generally a bank) is rewarded by interest and capital repayment of the loan and it is usually secured either on business assets or owner’s/shareholder’s personal assets. As a last resort, if the company defaults on its repayments, the lender can put business into receivership, which may lead to the liquidation of any assets. Debt which is secured in this way and which has a higher priority for repayment than that of general unsecured creditors is referred to as “senior debt”.
By contrast, private equity is not secured on any assets although part of the non-equity funding package provided by the private equity firm may seek some security. The private equity firm, therefore, often faces the risk of failure just like the other shareholders. The private equity firm is an equity business partner and is rewarded by the company’s success, generally achieving its principle return through realizing a capital gain through an “exit” which may include:
- Selling their shares back to the management;
- Selling the shares to another investor (such as another private equity firm);
- A trade sale (the sale of company shares to another investor /strategic partner/); or
- The company achieving a stock market listing (IPO).
On the other hand, some of the disadvantages of private equity capital, from the entrepreneur’s perspective could be seen in that:
- It is a lengthy process since private equity managers conduct detailed market, financial, legal, environmental and management due diligence, which could take several months before they make final decisions on investing;
- Entrepreneurs have to give up some of their company’s shares to a private equity investor, i.e. control; or
- The private equity managers have control over the timing of a sale of (a part of) the business.