There are thousands of private equity firms. As a business owner, how do you know which one is the best partner for your business? How do you avoid choosing the wrong partner?
Unfortunately for entrepreneurs, there is no “Yelp for private equity firms.” There are a few online portals which serve as a starting point, but the information on these websites is far from comprehensive. In some cases, it’s inaccurate and unhelpful.
For entrepreneurs who are beginning discussions with private equity firms, we’ve created a list of questions to help you better evaluate which private equity firms make sense for your business. If you need a quick refresher on what private equity firms do, see this post.
Question 1: Does the private equity firm pass an initial sniff test?
At the very least, Google the firm before you agree to a call or meeting. Nearly all reputable private equity firms have an online presence.
While information on firms’ websites is limited, you can determine high-level investment profile and criteria. If your business and transaction interests don’t align, then you will likely waste your time talking to the private equity firm. See this post for more information on private equity investment criteria.
Don’t forget to leverage the expertise of your network. If you have board members or colleagues who have experience with private equity firms, ask them for their opinion. This can provide valuable insight.
Question 2: Does the private equity firm invest in your preferred type of transaction?
There are two types of transactions: Liquidity and Growth Capital.
Liquidity is proceeds from a transaction used to cash out existing owners. This can be a full sale, or a partial sale, which is known as a recapitalization. Recapitalizations are either majority sales (>50% ownership) or minority sales (<50% ownership).
Growth capital is used to fund growth initiatives for the business. Many private equity firms will provide a combination of growth and liquidity to entrepreneurs.
Question 3: Does the private equity firm deploy the type of capital you want?
Private equity firms deploy two primary types of capital: Equity and Debt.
Equity is the most common form of capital. It is dilutive to entrepreneurs. Private equity firm gets equity ownership in the business.
Debt is non-dilutive to the existing owners but comes with an interest rate and principal repayment requirements.
Transactions are often funded with a combination of debt & equity. Private equity firms typically partner with third-party lenders to provide debt.
See this post on the different types of investors to give you a better sense of what type of capital makes sense based on the stage of your business.
Question 4: Does the private equity firm’s investment size line up with your business?
As a general rule of thumb, private equity firms invest about 10% of their total fund in each portfolio company. If a private equity firm has a $100M fund, it is a safe assumption they are looking to put $10M to work in each deal they do.
Question 5: Can the private equity firm help you meet future goals with follow-on capital?
Companies need additional capital for all sorts of reasons. Sometimes it’s because the company is struggling, other times it’s to fund growth initiatives such as acquisitions. Make sure you understand whether or not a private equity firm has the ability to fund additional cash.
If a private equity firm is nearing the end of its fund and hasn’t started raising an additional fund, they may be out of cash.
Question 6: Are you comfortable with where the private equity firm’s capital comes from?
Traditional private equity firms raise a dedicated fund from high net worth individuals and institutional investors. This is committed capital the private equity firm draws down on to make an investment.
However, some firms never raise a committed fund and are instead set up as “fundless sponsors” Fundless sponsors are either 1) pledge funds, who sign up a deal then raise capital, 2) investment clubs, which have a group of individuals who participate in deals on a deal by deal basis, or 3) family offices.
Whether it’s traditional private equity or a fundless sponsor, inquire as to who the underlying investors are. While rare, there are negative implications that can arise from who the investors in a fund are. For example, imagine if you took capital from a private equity firm, only to find out their largest investor has ties to extremist organizations.
Question 7: Do you understand the private equity firm’s management style?
Some firms are very involved in the day to day operations while others are passive investors who leave running the company up to the management team.
Question 8: Are you comfortable with the private equity firm’s oversight requirements?
There are two types of oversight requirements: Board seats and Reporting.
Firms will require management to share information on an annual, quarterly or even monthly basis. Ask for an example of existing portfolio reporting packages. This will help you understand the time commitment and resources needed to comply with oversight requirements.
Most PE firms will require at least one board seat. Some require multiple board seats.
Question 9: Does the private equity firm provide value-added capabilities?
Private equity firms will differentiate themselves by offering value-added capabilities. This is anything from a network of relationships, bulk purchasing power, operational resources, etc.
Question 10: Are you and the private equity firm on the same page for the strategic plan for the business?
If you are still running the business, have a clear understanding of the private equity firm’s goals. Are you on the same page with the growth strategy? Do you understand if the private equity firm is pushing for cost reductions?
Question 11: What is the firm’s track record?
Do the firm and the partners involved have a track record of success? Have they profitably invested in and helped build businesses? Probe on the key partner’s past experience.
The Most Important and Final Question: Can you work with these people for the next few years?
Do you want to partner with this firm and the people who represent it? Reflect carefully on each of your interactions with the firm. Ask for references from existing portfolio company executive teams to hear about their experiences.
How to Stay Organized When Evaluating Multiple Private Equity Firms
We recommend creating an excel database where you track each of the potential investment partners you meet. Every time you have a conversation with an investor, update your sheet.
For additional information on private equity, check out the private equity insider blog.