Expert Responses

I think you need to clarify the distinction between “Venture Capitalists” and “Private Equity” investors. Venture Capitalists of “VCs” will place very high demands on a NEW, usually pre-revenue businesses. They will want detailed business plans, budgets, staff plans, use of proceed reports, etc. They generally will take a large stake in the business and often protect their downside risk with creative structures such as convertible notes, warrants, liquidation preference shares, etc. I assume though, for privately held family businesses we are thinking more about Private Equity investors and most of these will focus on more mature businesses.

The overriding thing to consider with private equity investors is that they are NOT all equal. The saying that “all money is green” belies the fact that some private equity investors can, and do, provide significant strategic support and director for their investee companies.

This is one reason why hiring a specialist firm like Grant Thornton to determine not only how much funding will be required – whether that is debt or equity – but also determine which investor best suits the long-term interests of the company. For example, if the business is a food production business they may be well advised to look ONLY at private equity investors that have relevant food industry expertise. They will therefore understand the industry, supply chain dynamics, systems integration, etc. Through previous investments they may have contacts with new customers or suppliers, new geographic territories, etc.

The next thing to consider is the impact on the day-to-day operations of the business. Most private equity investors will want either monthly or quarterly financial reporting to be provided in a timely way. They will likely insist on changes to the Shareholders Agreements and Articles of Association to protect their investment. They may also insist on veto rights for such things as taking on new debt, large capital investments and dividend payments. They will almost always insist on anti-dilution protection to preserve their equity position. In some instances the investor may want to see the appointment of a more senior finance executive (CFO) to make sure that the financial side of the business is being run smoothly.

The other thing that family businesses need to be aware of when bringing in traditional private equity investors into their business is that their respective interests tend to diverge over time. Most of these professional investors have a closed-end fund which has a defined lifetime of approximately 10 years. Their own partnership agreement allows these funds to be drawn down and deployed for a period of approximately 3 years from the inception of the fund. They then have 3 to 4 years to ‘grow’ these businesses and 2 years or so to ‘harvest’ – i.e. SELL their respective interest in the business. As the business grows and, hopefully, becomes more successful, everyone will be happy with the results, but there comes a day when the private equity investors need to divest their interest and it may not be the considered the right time for the original shareholder’s perspective. These professional investors may also be more dispassionate regarding the timing and pricing of a sale in the future.

The last point I would make about private equity is that they may have a different tolerance for risk than private shareholders. They will therefore often want to leverage their investment in the company, which does put more strain on the business during economic downturns, like we are presently facing. This can also be a challenge for traditionally more conservative private owners of a business to accept and this issue will need to be discussed early on in any transaction with a private equity investor.