OPM
Other Private Money

By Phillip S. Dingle
Published: September / October 2008

The media is full of stories about private equity groups, most frequently in the context of buyouts on a national or international scale. A favorite local example is the recent privatization of OSI, Inc. -- the parent company of Outback Steakhouse -- by Bain Capital, Catterton Partners and the company’s founders. What few business owners may know is that private equity financing can be a valuable tool for growing smaller businesses as well.

Private equity is an asset class consisting of equity securities in privately-held companies. Private equity includes control buyouts, in which the private equity group (or “PEG”) acquires all or majority of a mature operating entity that generates positive cash flow; and growth capital investments, in which the PEG invests in mature companies seeking to expand without a change in control. Target companies for PEGs typically generate $10 million or more in annual revenues and may operate in a variety of industries. PEGs in this arena typically seek investments that will yield 2-5 times invested capital within a 3-7 year investment time horizon. The most attractive buyout opportunities are those that involve growing businesses in an industry the PEG likes, with recurring and sustainable revenues, solid management teams, less formidable competition, no real customer concentration and considerable barriers to entry for would-be new competitors.

When private equity financing is appropriate

For growing and profitable companies, there are two circumstances that may trigger an interest in private equity financing:

• The business needs capital to expand, grow and/or complete acquisitions.

• The business owner is interested in pursuing a majority buyout transaction in which he/she is able to “take cash off the table” while retaining equity in the business. Post-transaction, both the owner and the PEG have a vested interest in the company’s growth and success. This may be a particularly attractive proposition for the entrepreneur who possessed the technical knowledge to start the company, but has encountered trouble managing the company’s rapid growth and ever-increasing working capital requirements. By way of example, private equity also offers an alternative when there is no heir apparent to the CEO. Private equity firms can add value in such instances by tapping their network to place well qualified executives in the “C-suite.”

All PEGs are not created equal

Enterprises seeking private equity financing must conduct some targeted soul searching prior to selecting a partner. Do they want to work with a specialist in their industry or, alternatively, with a generalist firm? An operating-oriented PEG or a financially driven one? A local PEG or one located elsewhere?

There are pros and cons to each alternative. As for the specialist vs. generalist issue, I admit to being somewhat biased, as our firm focuses exclusively on healthcare. That said, my experience is that specialists are often exposed to deals that generalists might never see, because specialist funds maintain strong networks within their respective industries. Specialist firms also offer business owners industry-specific experience, frequently with operating expertise, which can bolster the existing team’s capabilities. Finally, and if possible, an owner should consider seeking a local PEG that meets most of his or her requirements, which typically provides better access and an increased likelihood of developing a mutually beneficial relationship.

How to identify and select a PEG

The business owner can pay an investment banker to conduct the search or run an auction, although smaller businesses sometimes go the do-it-yourself route. The owner should carefully research prospective funds to identify their preferred industries, and then perform an appropriate level of due diligence. This is a business of people, not just products -- and business owners should ask about each PEG’s track record, management practices and governance practices. The better respected the fund and the better its track record, the greater the likelihood of growth for the business. This is a two-way courtship. Both the owner and PEG need to sell themselves and establish the groundwork for the future relationship.

Words to the wise

Business owners should be prepared before contacting prospective equity partners, which means getting the company’s financials in order and deciding what the owners are looking for in an ideal transaction, including: (a) what percentage of the business they want to retain after the recapitalization; (b) the level of operational support management expects from its equity partner; and (c) how long the current management team is willing to own and actively manage the business. It’s important to be specific about growth aspirations and tactics.

In the long run, the best advice for the business owner is to select a partner carefully in terms of trust, credibility and experience. Making sure that the PEG’s goals, track record and expectations are closely aligned with those of the business will help ensure that it will be a successful business relationship.

About the Author
Phillip S. Dingle is a board member of ACG Tampa and managing partner of HealthEdge Investment Partners, LLC, a Tampa-based operating-oriented private equity firm that focuses exclusively on the healthcare industry. Prior to joining HealthEdge, he was CEO of publicly-traded PlanVista Corporation (formerly HealthPlan Services Corporation) from 2000 to 2004, when he sold the company. He also served as chairman of the board of PlanVista from 2001 to 2004.