Private Equity Investment – An Alternative to Management Consulting
Part 2: How our best clients get paid to multiply the valuations of their companies
In the first part of this blog, I described at a high level some of the key steps a family business needs to take to institutionalize itself and set the stage for exponential growth and premium valuations.
In this article, I describe how Private Equity investment into family businesses can help achieve the company’s objectives while minimizing recourse to external consultants.
As a case study, consider a family business that is in the following situation:
- Well positioned in an attractive sector of the economy
- Good track record of profitability and growth
- 100% family owned with family members and close partners controlling key roles in the business
- Potential for product and geographic expansion but insufficient resources to do so
- Management would be interested to consider an M&A exit or an IPO but is uncertain of how to get there, as “a lot of work needs to be done to be ready for an IPO”
Typically a business in this kind of situation could turn to a host of management consultancies to upgrade its team, systems, processes, governance etc. and eventually enhance the business and have it ready for a sale or IPO.
However, there is an alternative route, which consists in selling a stake to a Private Equity firm. Private Equity investors can actually drive massive change in the company and create tremendous amounts of value for the founders.
Below are the top reasons why I believe that Private Equity can be better than management consulting!
1. Private Equity has skin in the game
The most important factor is that the interests of a private equity investor are fully aligned with those of the owners of the company, towards value creation and valuation maximization.
An important disclaimer here is that, if you are not looking to maximize the valuation of your business, you should NOT seek investment from any financial investors, be they private equity, family offices, or IPO investors.
2. Private Equity has long term commitment
The other disclaimer is that private Equity will be focused on achieving an Exit, typically after 3 to 7 years. So alignment of interest is strongest when the founders are looking to go for a sale or an IPO in the near to medium term. At least, they need to be willing to facilitate the exit the private equity investors.
While the exit focus of private equity is sometimes seen as a negative by some companies, compare this to management consultants, whose fiduciary duty only extends to delivering good advice in their reports. Private Equity is with the company for better and for worse. Particularly if things go badly, Private Equity is “stuck” with the company and must do everything in their power to turn the business around.
3. Private Equity investors are focused on execution and accountable for it
While companies in this region are “addicted” to management consulting, they all recognize that the main “issue” with consultants is that they advise but not execute –by definition. On the other hand, private equity is all about effecting change and getting results. Having invested their money in the company, the private equity investors will typically sit on the board and contribute to change in a multitude of ways, subject to their agreements with the founders:
- Participate in recruitment, or even appoint one of their people to the management team, particularly to the finance functions
- Closely monitor financial planning and performance
- Focus on margin improvement
- Enhance corporate governance to ensure the company is optimally run and minority rights are protected
- Participate in business development via their broad relationship networks as well as public relations capabilities
4. And last but not least! Whereas Private Equity gives money to the company, the Company has to give money to Management Consulting
At the risk of stating the obvious, Private Equity is all about funding the business and its growth plans! PE investors can also buy out a part of the founders’ equity but their preference is always to back the growth plans of the management team. The business may have sufficient cash-flow generation to finance its growth but entrepreneurs also like sharing the risks of what may seem like a bold growth strategy, such as expanding into foreign countries etc. Having expert investors on side, who have invested in many other companies and successfully backed similar strategies, can also be a great confidence booster for management and founders.
In conclusion, for companies looking to increase their valuations and who are willing to raise their corporate governance standards, a private equity investment can be a great alternative to management consulting services. Or, to put it differently, the non-financial benefits of taking an investment from a private equity firm should be considered very carefully.