1. Why Capital Markets?

1.3. Private Equity

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1.3.1. Why choose Private Equity and Venture Capital-based financing?

Private equity (“PE”) provides typically medium to long-term committed equity and debt to help Companies grow and succeed. If you are looking to start up, expand, buy into a business buy out a division of your parent Company, turnaround or revitalise a Company, private equity could help you to do this.

Obtaining private equity is very different from raising debt or a loan from a lender, such as a bank. Lenders have a legal right to interest on a loan and repayment of the capital, irrespective of your success or failure.

Private equity is invested in exchange for a stake in your Company and, as shareholders, the investors’ returns are dependent on the growth and profitability of your business. Therefore, private equity investment also requires a previous due diligence and certain investment protection mechanisms (e.g. regarding the Company’s decision-making process and transfer of the shares).

Venture Capital (“VC”) is a form of PE and a type of financing specifically targeted at companies at a very early stage of their activity (“Seed” and “Startup”) and at small companies with high growth potential. This type of investment depends on an adequate provision of information since it tends to be riskier. Therefore, VC investors require a high potential of return to compensate the high-risk profile of these businesses (e.g., which are at a very early stage of their economic life cycle and where a high failure rate is observed).

VC investors can be a good way to reduce business risks, as they are professionals who enable the access to other specialists, provide guidance and support based on their knowledge and experience in managing other businesses that were also in the early stages of the life cycle (i.e. of the business, project or product).

Private equity financing has some distinct advantages over other forms of funding. Here are some of the main benefits:

PE firms have deep pockets and can provide the financial resources to fuel growth. Investment amounts can be large and can finance the capital required for large projects, such as expansion into new markets, construction of new facilities, purchase of new equipment, launch of major marketing campaigns, research and development of new products.

In addition, and over time, it is also common to have more than one VC manager financing the business, either to benefit risk diversification or the size of the business.

Simply being the target of PE attracts more and better talent to your company. In addition, PE firms can easily put you in touch with other experts who can help you achieve your business growth objectives, whether that means avoiding the mistakes others have made in similar situations, moving into new markets or customer segments, launching online distribution, or fulfilling some other essential need to grow your business.

Additionally, PE firms have a strong network in the business community and can support you in finding new opportunities. Tapping into these networks may have tremendous benefits.

From the moment a PE firm invests in the equity of a company (or in a business) it becomes its shareholder, being able to share the responsibility for how the funds are applied and sharing the return on investment. As such, PEs are willing to get involved and intervene in your business’ operations, lending you their skills, expertise and access to useful contacts.

Their involvement could also prove invaluable in helping you make key business decisions and develop an effective strategy, allowing you to benefit from their knowledge and experience. Opening the share capital to PE firms, also allows entrepreneurs to lower their individual financial risk as they reduce the concentration of their investment and assets.

PE funding may be a preceding-step for an IPO given it will prepare the Company for public exposure since:

  • Increases the number of investors and stakeholders in the company which tends to increase the diversity of knowledge, competence and competitiveness;
  • PE investment leads to the professionalization of the management team;
  • PE investors implement best practices in terms of operations and governance;
  • PE investors will require the Company to have in place reporting systems and discipline to present to them the Company’s results.

The expertise of the PE may also be helpful to enhance your Company’s valuation prior to the IPO as well as to navigate the Company into the public offer process.

1.3.2. Private Equity Financing

1.3.2.1. What will make my business an attractive investment prospect for Private Equity firms?

Some private equity firms manage a range of different funds in which their companies’ investment preferences may differ. These preferences are normally presented on the PEs’ website.

If you decide to hire a financial advisor for the purpose of obtaining funding, he may be able to introduce you to their Private Equity contacts and assist you in identifying the right Private Equity firm.

The key considerations to assess the best PE to target are as follows:

The terms that most Private Equity firms use to define the type of investment are determined by the purpose for which the financing is required.

  • Seed financing – Very early-stage financing intended to allow for a business concept to be developed, sometimes involving the production of a Business Plan, prototypes and additional research, prior to bringing a product to market and beginning large-scale manufacturing.
  • Startup financing – Intended to fund the development of the Company’s products and/or services and fund their initial marketing. Companies may be in the process of being setup or may have been operating for a short time, but have not established their product commercially.
  • Early stage financing – Financing still on an early stage, but after the startup phase. Generally intended to increase production scale and/or to initiate marketing and sales in companies that have completed the product development stage but may still not be turning a profit just yet.
  • Expansion – To grow and expand an established Company. For example, to finance a revamp and increase of production capacity, product development, marketing and to provide additional working capital. Also known as “development” or “growth” capital.
  • Restructuring/turnaround – To finance a distressed Company and promote a turnaround in the business, usually to save it from bankruptcy.
  • Bridge financing – A form of temporary financing intended to cover a Company’s short-term costs until the moment when regular long-term financing (which can be in the form of Market-based financing) is secured. Thus, it is named as bridge financing since it is like a bridge that connects a company to debt capital through short-term borrowings.

Most private equity firms will consider investing in a wide range of industries, provided that the Company meets their other investment preferences or investment criteria. Some PEs specialise in specific industry sectors (e.g. biotechnology, IT and other areas, Real-Estate, etc.).

Most PE firms have a ticket size preferences that may greatly differ from hundreds of thousand euros to millions euros. This ultimately depends on the investment policy of the funds managed by the PE. Nevertheless, usually Companies seeking smaller amounts of funding are more attractive to PE firms if there is an opportunity for further rounds of private equity investment later down the road.

It should be noted, that in terms of the amount of time and effort PEs need to spend in appraising the business proposal prior to investment, the investment process is fairly similar regardless of the investment amount. Nevertheless, although bigger investments tend to be more scrutinized, they tend to be more attractive for PE investment, as the absolute return is likely to be greater than for smaller investments, and should more easily cover the initial costs.

It should be noted that Portugal has a strong presence of local PEs.

Geographical location as an investment factor is much more important for foreign PEs.

In terms of geographical attractiveness for investment, Portugal is seen as a very attractive location, being among the top European destinations for Direct Foreign Investment (FDI).

To these considerations, it also should be added:

  • The track record of the PE firm and its reputation in the market, notably in managing investments similar to the one sought by your Company.
  • The proposed financing conditions and the perspective of evolution of the business relationship.

You should approach the entities whose investment preferences match your situation.

1.3.2.2. How should I prepare my business if I’m looking for investment from a PE firm?

The first step should be to prepare a Business Plan and to have a clear definition of what is your business’ value proposition to present to a new investor.

A Business Plan should be considered as an essential document for potential shareholders as it enables them to assess the future prospects for business performance, review the business’ strengths and weaknesses, and to identify critical success factors and what must be done to achieve profitable growth. It can also be used as a basis for identifying the potential need to reorganize internal functions.

Professional advisors can provide a vital role in critically reviewing the draft Business Plan. However, it is you who must take the ownership of the plan when presenting it to any investor.

The Business Plan should cover the following elements:

You need to show the PE firm that there is a real commercial opportunity for the Company and its products and services. This requires a careful analysis of the market potential for your products or services and how you plan to develop and penetrate the market. Information about the following elements should be provided:

  • Market analysis
  • Marketing plan
  • Pricing
  • Distribution channels
  • Promotion
  • Competition

Explain the Company’s product or service in a simple way. If the product or service is technically orientated this is essential, as it has to be readily understood by non-specialists. Emphasise the product or service’s competitive edge. You need to convince the PE firm that the product or service is good and fulfilling a market need.

PEs invest in people – people who have run or who are likely to run a successful business. Potential investors will look closely to the members of the management team. This section of the plan should introduce the management team and what its members bring to the business. Include their knowledge and experience, their drive, resilience, and ambition. In this section it should be demonstrated that the Company has the quality of management to be able to turn the Business Plan into reality. In other words, you need to convince the PE firm that the management team is fit to the job.

This section of the business plan should explain how your business operates, including how the Company produces the products or provide the services. It should also outline the Company’s approach to research and development.

It should include details on the location and size of the facilities. Factors such as the availability of labour, accessibility of materials, proximity to distribution channels, and the availability of Government grants and tax incentives should be mentioned. Describe the equipment used or planned and, if more equipment is required in response to production demands, include plans for financing it.

These and any other operational factors that might be important to the investor should be included.

Developing a detailed set of financial projections will help to demonstrate to the investor that you have properly thought out the financial implications of your Company’s growth plans. PEs will use these projections to determine if:

  • The Company offers enough growth potential to deliver the type of return on investment that the investor is seeking.
  • The projections are realistic enough to give the Company a reasonable chance of attaining them.

Investors will expect to see a full set of cohesive financial statements – including a balance sheet, income statement and cash-flow statement, for a period of three to five years. Ensure that these are easy to update and adjust. Do include notes that explain the major assumptions used to develop the revenue and expense items and explain the research you have undertaken to support these assumptions.

In this section of the Business Plan you need to state how much funding is required by your business and from what sources (current shareholders, PE firm, banks and others) and explain how the funds are expected to be used (fixed assets, working capital, etc.).

Finally include the consideration how the PE investors will make a return, i.e. realise their investment.

1.3.2.3. How does the PE investment process then take place?

The investment process, from reviewing the Business Plan to actually investing can take a PE firm up to one year, but typically it takes between three and six months. There are exceptions in which deals can be done in extremely short time frames. Much depends on the quality of information made available to PE firm and the business quality. Bellow you can find a description of the main stages of the PE investment process.

After the agreement is signed and the funds have been transferred, you’ll start working with the private equity firm. Normally PEs will have an active approach aiming to add value to your Company.

In addition to advising on strategy, including such matters as entering new markets, developing new products, making new investments for increased production capacity or efficiency, making new acquisitions and hiring new management, the PE will have a strong business network to share with you, possibly including introductions to potential customers, suppliers, acquisition targets and even to other PE firms in connection with syndicating financing rounds.

The PE usually aims to be your partner, someone to be approached for helpful ideas and discussion. Backing from a PE can provide credibility and status in dealing with third parties. However, day-to-day operational control is rarely wanted. In order to provide this support, normally PEs will expect to have seats on your board. The directors may be executives from the PE or external experienced executives.

Additionally, to be able to oversight the evolution of your Company, the PE will expect to:

  • Receive copies of your management accounts, promptly after each month end.
  • Receive copies of the minutes of the board of directors’ meetings.
  • Be consulted and involved in, and sometimes have the right to veto, any important decisions affecting the Company’s business. This will include major capital purchases, changes in strategic direction, business acquisitions and disposals, appointment of directors and auditors, obtaining additional borrowings, etc.

1.3.2.4. How the PE will realize its investment?

Many shareholders are looking at some point to sell their investment or seek a stock market listing in order to realise a capital gain. PE firms usually also require an exit route in order to realise a return on their investments.

The time frame from investment to exit can be as little as two years or as much as ten. At the time of exit, the private equity firm may not sell all the shares it holds. In the case of an IPO, private PEs are likely to continue to hold the newly listed shares for a year or more. The main exit options are listed below:

  • Trade sale – The sale of your Company’s shares to another investor e.g. institutional investor).
  • Repurchase – The repurchase of the private equity investors’ shares by the Company and/or its management.
  • Execution of an IPO – In this exit option, is worth mentioning that the Company, upon the PE investment may be better prepared given the reporting systems and discipline will be already implemented in your Company.

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