Private Equity: What Does It Bring To The Table?

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In Expert Q&A Paris Aden - Private Equity

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[mk_dropcaps style=”simple-style”]Q:[/mk_dropcaps]
Private equity funds clearly bring M&A capability (for add-on acquisitions) and contacts to the businesses in which they invest. Do these funds also bring hands-on detailed operating experience and related benefits to the table?

 

[mk_dropcaps style=”simple-style”]A:[/mk_dropcaps]

Access to capital and transaction structuring

Private equity funds do bring additional transaction structuring and preferred access to capital to the portfolio companies that they invest in.

Private equity funds also form powerful buying groups for their investee companies for other things like professional services. As a result they can assist in negotiating better terms than might otherwise result for such things as professional services, insurance and third party borrowing costs.

Governance, management and other discipline

In terms of the value that a private equity fund brings to the table in addition to the transaction experience and that buying power, generally speaking private equity funds will bring improved governance expertise and discipline to an investee company.

These things manifest themselves in such things as (1) an improved, more professional and better disciplined Board of Directors, (2) implementation of improved financial management reporting systems, and (3) very importantly, migration of an investee business from an entrepreneurial model to an arm’s length corporate governance model, or stated differently from “a successful owner managed business into a professionally managed company”.

The other principle that a private equity investor will typically apply is velocity. For private equity to generate extraordinary returns over a relatively short hold period, the transformation of the business must happen rapidly. For example, if a private equity investor invests $100 million and realizes $250 million on exit, they would likely be very pleased. 2.5 times invested capital is a very nice result. However, the internal rate of return (IRR) on that investment is very sensitive to time. In this example, the outcome achieved over 3 years would translate into a 36% IRR. Over 5 years, the IRR on this investment would be 20% and over 10 years, it would be only 10%.

It is important for private company business owners to understand that private equity funds are strong in their governance and they’re also strong in the organizational changes that are required to transform the business into more of a professionally managed corporation or company. Those changes typically contribute to business growth and value growth – and result in a business being more marketable at a higher price than it otherwise would be.

Private equity hands-on operating expertise

In terms of actual operational expertise again, because the private equity market has become so much more competitive we are seeing a lot of funds that tend to focus very narrowly in certain domains and certain industries. In those select cases there may be fund managers that have extensive industry experience that enables them to provide some additional strategic and operational insight to their investment partners.

It is also becoming increasingly common for private equity funds to develop in-house operating capability through operating advisors, executives in residence and sponsoring executives in career transition to acquire new platform companies.

That said, private equity funds generally speaking are not operators. Rather they are investors that usually bring additional strategic value and perspective. Typically they add value to the companies they invest in by enhancing the structure, discipline and extending the industry and other contacts of their investee companies.

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Paris Aden BA (Economics) CFA

Paris Aden is a Partner in Toronto and Montreal based Valitas Capital Partners. His investment banking experience includes working with clients at Morgan Stanley, Credit Suisse and RBC Capital Markets.  He has direct investing experience with private equity firm Clairvest Group and co-founded Alluence Capital Advisors, a mid-market M&A advisory firm. Over the past 20 years Paris has been involved in over 100 M&A transactions with an aggregate value in excess of $80 billion.

Paris lectures at the Smith School of Business at Queen’s University in the Master of Finance (MFIN) program, and is an instructor and facilitator for Moody’s Analytics’ Advanced Capital Markets Program for capital markets professionals.

You can reach Paris at paris.aden@valitascapital.com, or by telephone at 416 556 0887.

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