What is Private Equity in Simple Terms?
Private equity firms aim to invest in companies, improve them, and then sell them. The goal is to make a profit through the entire lifecycle from purchase to eventual sale. While this cycle time called a hold period varies, it is frequently around three to four years. This means at the end of the hold period, the firm must sell the company.
The firm’s manager, called a General Partner, is in charge of raising funds from investors and manages these funds. To have some “skin in the game” the General Partner also contributes to the fund, usually one to three percent of the total. When the investment later generates positive returns, the investors benefit from this financial gain.
Private Equity 101: Pros of Private Equity
Private equity firms have two major benefits: experience and financial resources. While transaction experience helps ensure the deal closes, industry experience and resources can help the company grow.
Transaction Experience
Successful private equity firms have a long track record of closing deals. Conducting due diligence, securing debt financing, and legal documentation are all areas of expertise. If you sell your business to a private equity firm, the transaction will likely run smoothly.
Financial Resources
If a company is at a crossroads and is considering an exit, a growth equity investment, or a leveraged recapitalization, private equity firms can provide the needed capital. If the private equity firm makes the right choices, the additional capital can make a positive impact.
Industry Experience
Some private equity firms specialize in a certain industry, like the technology sector for example. This industry experience can make future growth outcomes favorable: the private equity firm has specialized knowledge that, in theory, can take the company to new heights under its ownership.
Cons of Private Equity
Part of private equity 101 is understanding its limitations. Just as firms can use their resources and knowledge to elevate a company, the short investment time horizon could harm the business’s long term health. For some firms, the limited investment period means there is more focus on turning a short-term profit rather than making long-term investment decisions for the company.
Short-term Focus
As mentioned, private equity firms’ investment period is predetermined. This means firms have a short window to maximize company growth and generate positive returns for investors. While sometimes this can benefit the company, aggressive growth tactics can be harmful to long-term success. Private equity firms may be more motivated by making a profit in the short term rather than setting the company up for true long term growth. This is where the negative stereotype “turn and burn” or “flipping” comes from: firms that only care about quickly turning a profit, effectively “burning” the company in the process.
How is Small Business Private Equity Different?
Due to the nature of working with smaller businesses, small business private equity typically makes smaller investments. While definitions vary, most people would consider small business private equity firms to make equity investments of between $5 and $50 million in transactions valued from $20 million to $250 million. Larger private equity firms would not consider transactions of this size, unless they were part of an add-on to an existing portfolio company.
In small business private equity the General Partner typically contributes a larger percentage of capital to the fund than in bigger business private equity. Instead of one to three percent, it may be as high as ten percent.
More Hands On
Compared to their larger counterparts, small business private equity firms are often more hands on. Where larger firms are usually involved at the board level, small business private equity firms might be more engaged in business operations. This is a benefit when the firm has industry experience that could help improve the company.
BEYOND PRIVATE EQUITY
An alternative to private equity is the private investor. Private investors are often local and know the company on a personal level, increasing their ability to make a positive impact. They also frequently invest their own capital and do not manage committed capital funds, meaning they are personally dedicated to the company’s success. In addition, they frequently have open-ended investment time horizons. This means the company’s long term success is the investor’s success, motivating the investor to make the best choices for the company’s health. There is no risk of a private investor wanting to “turn and burn” or “flip” a company for short-term profit.
On the flip side, private investors might not have transaction experience or relevant industry experience. The lack of transaction experience might negatively impact the ability to close the investment.
1719 Partners’ Approach
1719 Partners has both the ability to close transactions and all the benefits of being a private investor. Our track record demonstrates our experience: we have closed over 40 transactions. Our financing connections ensure we will be able to close many more deals in the years to come.
1719 aims to carry on companies’ legacies, building businesses that will succeed for generations to come. This vision aligns with that of many multigenerational business owners.
Without the limitations of a predetermined investment horizon, we are free to accomplish this vision, growing our portfolio companies at the pace best for each company. Effectively, 1719 has all the perks of a private equity firm without any of the downsides.
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