By Nickolas Lim, Managing Director, FAX Capital Corp.
Heightened market volatility in response to global macro events has made public capital raising more difficult for small and medium-sized enterprises (SMEs) as investors become increasingly selective.
SMEs may want to consider private equity as an alternative financing option. Private equity often has a longer investment horizon and evaluates companies based on persistent structural advantages rather than current market trends or short-term catalysts. Timing has also never been better. According to Bain & Co. Inc.’s Global Private Equity Report 2021, private equity funds are sitting on a record US$3.4-trillion of unspent capital trying to find a home.
Here are three considerations for SMEs interested in private equity as a potential financing path to funding growth.
Get a feel for the private equity landscape:
All private equity firms share one common characteristic: they are experts in business transformation to create value. However, they can diverge considerably in the types of businesses they choose to invest.
Some focus on growing businesses, others on mature businesses and others on operational turnarounds. Private equity firms can also have sector expertise while others are generalists. Some firms are active investors while others are passive.
In the case of FAX Capital, our business is structured as a corporation and acts as a permanent capital vehicle, unlike a typical investment fund which is structured with a finite investment period. We take significant ownership positions or outright control of high-quality public and private companies and help them transform and scale over long periods of time, preferably indefinitely.
For example, FAX Capital acquired 78 percent of Carson, Dunlop & Associates Ltd., a home inspection software and education company, partnering with the founder who remains a significant equity owner. FAX Capital’s involvement has included appointing a proven operating executive to help lead the business, launching a digital transformation effort that will help it evolve into the emerging property-technology space, and executing synergistic acquisitions. In the one year that FAX Capital has owned Carson Dunlop, it has significantly reinvested into the business and closed on two accretive acquisitions.
A review of potential private equity suitors can help you determine which one is most likely to align with your goals. Be clear on your intent to make sure your new partner will be supportive of your vision.
Private Equity: An alternative financing option for SMEs looking to raise capital during periods of volatility Share on X
What to expect from private equity:
A genuine partnership, but only after clearly communicating well-defined strategic goals.
Leadership at private equity firms comes with deep domain expertise as business operators collaborate with owners to help them achieve various outcomes. That can include diversifying product portfolios or creating entirely new ones; accessing new markets by leveraging their extensive networks; introducing operational efficiencies to reduce costs and increase profitability, and helping plan to exit a business for founders who want to sell and retire.
Private equity firms can also be sensitive to how a company transitions through changes in ownership and during its evolution to a new stage of growth. For that reason, many prefer that key members of management remain onboard to ensure institutional knowledge isn’t lost during a transition, and operations run smoothly.
Of course, there is also the matter of valuations where differences in opinion can lead to spirited debate. There’s a lot that goes into price discovery that will include an appraisal of your intellectual property, technology, research and development, revenue, cash flow, and recent comparable transactions. Current global events could also add a layer of complexity in terms of forecasting.
Expect private equity firms to look under the hood of your business and ask detailed questions to make an informed decision on deal terms and structure.
Impact of global events on M&A negotiations:
While having a long-term view creates opportunities to identify businesses that might otherwise be out of favour, private equity firms will consider potential structural changes brought forward by recent global events. The pandemic and war in Europe have unquestionably impacted merger and acquisition negotiations to some extent, but each situation is unique.
Many deals include a Material Adverse Effects (MAE) clause, which reduces or eliminates the buyer’s obligation to complete a deal based on substantial changes to a target acquisition’s profitability. The suddenness with which global events reshape our lives can just as quickly alter entire industries and, in some cases, cripple companies altogether. Just look at how the pandemic has impacted the travel, entertainment and hospitality industries.
For the same reason, there is a greater emphasis on risk mitigation. Business continuity, privacy and cybersecurity, liability exposure and human resources policies are closely scrutinized to assess the risk of significant disruptions to the business.
Negotiations in private equity deals can be exhaustive – and exhausting – and SME owners should be prepared to answer all manner of questions which is time-consuming and distracting for those simultaneously trying to run the day-to-day operations of a business.
Global events will continue to shape our immediate future – geopolitical instability, rising inflation and a lingering pandemic all factor into how investors evaluate opportunities. The difference between raising capital via private equity vs. public markets is that private equity typically has a longer time horizon which mitigates short-term business volatility.
