Venture capital (VC) and private equity (PE) play increasingly important roles in the funding landscape but are not to be confused with each other.
“VC typically invests in early-stage companies, often start-ups that are in the initial phases of development,” says James Toomey, partner, financial advisory, Deloitte. “These companies usually have high growth potential but may not yet be profitable. The capital typically is invested into the company to facilitate the future growth of the business, with limited, if any, cash paid out to shareholders.”
Private equity, by contrast, focuses on investing in more mature, established businesses that have a proven track record.
“These companies are often looking for capital to expand, restructure or enter new markets,” explains Toomey. “The capital can be invested into the company to facilitate the future growth of the business but it is also common that cash is paid out to shareholders as consideration for their shares.”
Sometimes companies use the terms interchangeably but erroneously so, says Keith McDonagh, head of corporate finance at business advisory firm Xeinadin.
“Venture capital is early-stage growth funding. It’s much more high risk,” says McDonagh. “You might be pre-revenue. You might not even know that the idea can make money. Whereas private equity happens after the fact and is there to support a growth phase or a specific strategic approach.”
Such strategic approaches can include either horizontal or vertical integration – that is, buying out your competitors to improve economies of scale or buying out companies up or down your supply chain to boost margin. Both are strategies PE houses can get behind.
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“They love good strong revenue sources, margins that are really good and can be made better, and stable or growth sectors,” says McDonagh.
For mature businesses looking to secure funds, PE is all about showing how far you’ve come and how much more you plan to do.
“Private equity houses buy into the experience of the management team. They look at the skills, the sector, the plan and the strategy,” explains McDonagh.
In return the PE house wants to know how long the process is going to take, when are they going to get their money back and what will they get in return.
“A PE house will normally look at a three-to-seven-year return, while venture capital is going to be significantly longer because you’ve got to bring [the business] all the way to fruition,” says McDonagh.
Private equity provides substantial financial resources that can be used for a variety of purposes, whether expanding operations, entering new markets or allowing existing shareholders to cash out, says Anya Cummins, partner and head of financial advisory at Deloitte. It also offers strategic support, including guidance at board level to help shape the company’s strategic direction.
“This can include filling key management positions, appointing a chairperson and providing strategic advice,” says Cummnins.
Depending on its style, PE firms might also take an active role in improving the company’s operations, she adds. This could involve streamlining processes, driving efficiency or enhancing productivity. They can also bring deep industry knowledge and valuable connections that can open doors to new opportunities, partnerships and markets.
“Where relevant we see PE funds take an active role in supporting the development and execution of M&A [mergers and acquisitions] strategies,” says Cummins.
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PE also offers an opportunity for shareholder alignment, allowing shareholders who wish to sell their shares to do so to the PE fund, ensuring that all continuing shareholders are in agreement on the future growth of the business. In providing shareholder liquidity, it allows existing shareholders to de-risk by taking some or all of their cash off the table.
“This can be particularly appealing for founders or early investors looking to realise some of their investment, particularly when the majority of the founder’s wealth is tied up in the business or for shareholders of different ages or stages of their career,” says Toomey.
While VCs will invest in numerous ventures in the hope that, say, one in 10 will win big, returning enough to cover the rest – and more – PE doesn’t tend to tolerate failures within its portfolio.
“The general thesis is that they’re looking to make money on all their deals, or at least not lose money in any of their deals. So they need the whole portfolio to perform over time,” explains Don Harrington, head of growth capital at Goodbody.
The big drivers of PE investments are often what Harrington calls the three Ds. “Very often those life moments – whether it’s death, disease or divorce – will drive something. It could be a founder-owned business looking to retire where the management team wants to buy them out but can’t afford to do it on their own. So they partner with the private equity fund to buy out the original founders. Or it could be that the founder is ill or getting divorced.”
PE can come in and professionalise a business if they haven’t had professional investors before. They’ll do the simple things like look at how you price your business to see, can we drive revenue up?
— Don Harrington, Goodbody
Currently around 80 per cent of mergers and acquisitions are either sold directly to private equity or to companies that are backed by private equity funds.
“Private equity can come in and professionalise a business if they haven’t had professional investors before. They’ll do the simple things like look at how you price your business to see, can we drive revenue up? Can we improve gross margin? Can we cut costs? Can we source things more efficiently?” explains Harrington.
Certain sectors are in particular demand, including renewables and technology, particularly engineering firms selling into the data-centre space.
The insurance sector has seen consolidation and healthcare providers are also in demand, including the roll-up of both GP and veterinary practices into bigger corporate entities, often in cases where owners were already thinking about their exit.
If you’re a business owner intent on attracting PE attention, there’s work to be done first, including ensuring you have a strong financial plan, a good cash flow position and customer contracts and intellectual property all securely tied down, he advises. Whether it’s a planned exit or an unsolicited bid, “have yourself prepared for any transaction,” says Harrington.
