Young companies - or even relatively mature businesses wanting to move to the next level of expansion - often need additional capital to achieve their aspirations. These new funds can be used to increase capacity, hire additional staff or enhance marketing efforts.

The most common sources of growth capital for most entrepreneurs are: 1) the entrepreneur's savings, 2) home equity, or 3) "friends, fools & family" (the "Three F's"). However, in order to realize the potential of the business opportunities, many entrepreneurs need to source external capital, either through banks or other institutional sources. The entrepreneur needs to understand the opportunities - and limitations - of these sources of capital to get the most impact for their business.

Banks

Entrepreneurs have traditionally looked to the banks as a provider of credit in the form of secured loans (with collateral) or credit lines (shorter term, unsecured overdraft facilities). But because the business owner often has limited business track record or lacks sufficient assets to use as collateral, this route can often prove to be frustrating and ultimately unsuccessful.

If an entrepreneur is fortunate enough to be granted bank credit, there are usually onerous strings and conditions - including personal sureties - attached. Because banks are managing thousands of loans, it is generally impossible for them to tailor loan terms according to the needs of each specific client. Understandably, their rules and conditions need to be quite standard and rigid, driving most entrepreneurs to rebel against the banks’ "cookie cutter" approach to granting credit.

Banks set rigid repayment terms for both interest and capital, often during the more difficult, high growth trading periods in the life of a young or fast growing business. Given the cash requirements of high growth periods, these obligations can be difficult to meet. Often the business owner then has to revisit and renegotiate loan terms with his bank and he has to defend why he and his business are still worth being financed. 

Private Equity

A lesser known and very different route to raising growth capital is that of private equity. Venture capital (investments in early start up companies) and private equity (management buyouts, leveraged buyouts and other recapitalizations) are just some of the more common terms bandied around the industry.

At its most basic, "private equity" is where the finance provider purchases a significant equity stake in the business, thereby reducing the owner or founder’s stake, but with a view to growing the value of the company to the benefit of all remaining shareholders. In some instances, equity purchases are sometimes coupled with the provision of traditional loan finance.

This alternative can offer several benefits in contrast to the standard banking finance route:

In contrast to a rigid bank credit process that differs very little from company to company in the same or similar industries, a private equity transaction is specifically designed for the unique characteristics of business. The capital structure is tailored to give the shareholders the best chance of value creation over the medium-to-long term.

The private equity partner usually appoints a director to the board and adopts a very hands-on approach. This is not a remote relationship. There is a direct interface between the business owner and the private equity partner and the relationship is accommodating and flexible.

Another benefit that private equity financing offers is that the incoming partner plays a business mentoring role that adds significant value. The private equity partner goes way beyond merely attending quarterly or monthly board meetings. Parties can interact every week or even every few days, depending on the size of the business and how advanced it is. Private equity investors are closely involved with business strategy, corporate governance and organisational development. In emerging markets in particular, a key function of the private equity investor is the identification and recruitment of senior management.

Private equity partners are more patient than banks and have a long term view, typically between four to seven years. In general, the investor assists the business as it grows, watching out for potential pitfalls and addressing them sooner rather than later. The fortunes of the business are followed extremely closely and any bad news does not come as a surprise.

Developing businesses considering all sources of capital need to be aware that although there are no regular financing costs such as interest like on a bank loan, in the long run private equity can be more expensive than loan finance. In this case, an owner or founder is giving up an equity interest and foregoing some portion of capital appreciation.

Despite their long time horizons with respect to their investments, all private equity financiers have an exit strategy where they will sell their investment at some point. In order to raise new capital to invest in other growth businesses, the investor must return capital to their shareholders or limited partners. The exit strategy can be realized through a stock exchange listing, a sale of the whole company, or a sale of the investor’s stake to a new equity partner.

Is Private Equity Right for You?

Private equity is not suited to those owners who are satisfied with the lifestyle, income level and wealth creation in their current business. These "lifestyle entrepreneurs" can be terrific business people, but the growth expectations of new shareholders may clash with owner’s satisfaction with the business’ current results.

Further, a private equity investment without a controlling shareholding is usually not appropriate for most family-owned operations. As blood is often thicker than money, family loyalties, sibling rivalries or inheritance issues often make this an investment area with too much potential for conflict. However, when a founder or owner is looking to bring in professional management while reducing his or her equity stake in the business, these are often strong investment cases for the right private equity partner.

New entrepreneurs with limited track records will struggle to find funding from banks or private equity providers. Private equity managers usually prefer to see businesses that have reached a certain turnover level. Even if they are loss-making, they’d like to see the company to have achieved certain operating or revenue milestones before they will consider investing.

In summary, a private equity investment would appeal to those who are highly ambitious and energetic and want to create substantial additional value in their businesses. There has to be chemistry and a commonality between all shareholders and managers. And, finally, the original founders must realise they will no longer be running it only for themselves - other parties are now involved, but those parties also want to maximize the value of the business.

Key questions for entrepreneurs considering private equity:

• Are you convinced your business could be substantially more valuable, even though it might take more effort on your part?
• Does your industry have attractive characteristics in terms of growth nationally or internationally?

• Is capital a substantial constraint to growth?

• If you raised more capital, do you have a detailed plan to spend the money judiciously?

• Do you have the management capability and depth in your business to realize your aspirations?

• Are you a good listener and can you work well with peers?

• Are you willing to own a smaller piece of a potentially much larger, more valuable pie?

If your answer to all  of the above is an unqualified "yes" please contact us on info@horizonequity.co.za.

Young companies - or even relatively mature businesses wanting to move to the next level of expansion - often need additional capital to achieve their aspirations. These new funds can be used to increase capacity, hire additional staff or enhance marketing efforts.

The most common sources of growth capital for most entrepreneurs are: 1) the entrepreneur's savings, 2) home equity, or 3) "friends, fools & family" (the "Three F's"). However, in order to realize the potential of the business opportunities, many entrepreneurs need to source external capital, either through banks or other institutional sources. The entrepreneur needs to understand the opportunities - and limitations - of these sources of capital to get the most impact for their business.

Banks

Entrepreneurs have traditionally looked to the banks as a provider of credit in the form of secured loans (with collateral) or credit lines (shorter term, unsecured overdraft facilities). But because the business owner often has limited business track record or lacks sufficient assets to use as collateral, this route can often prove to be frustrating and ultimately unsuccessful.

If an entrepreneur is fortunate enough to be granted bank credit, there are usually onerous strings and conditions - including personal sureties - attached. Because banks are managing thousands of loans, it is generally impossible for them to tailor loan terms according to the needs of each specific client. Understandably, their rules and conditions need to be quite standard and rigid, driving most entrepreneurs to rebel against the banks’ "cookie cutter" approach to granting credit.

Banks set rigid repayment terms for both interest and capital, often during the more difficult, high growth trading periods in the life of a young or fast growing business. Given the cash requirements of high growth periods, these obligations can be difficult to meet. Often the business owner then has to revisit and renegotiate loan terms with his bank and he has to defend why he and his business are still worth being financed. 

Private Equity

A lesser known and very different route to raising growth capital is that of private equity. Venture capital (investments in early start up companies) and private equity (management buyouts, leveraged buyouts and other recapitalizations) are just some of the more common terms bandied around the industry.

At its most basic, "private equity" is where the finance provider purchases a significant equity stake in the business, thereby reducing the owner or founder’s stake, but with a view to growing the value of the company to the benefit of all remaining shareholders. In some instances, equity purchases are sometimes coupled with the provision of traditional loan finance.

This alternative can offer several benefits in contrast to the standard banking finance route:

In contrast to a rigid bank credit process that differs very little from company to company in the same or similar industries, a private equity transaction is specifically designed for the unique characteristics of business. The capital structure is tailored to give the shareholders the best chance of value creation over the medium-to-long term.

The private equity partner usually appoints a director to the board and adopts a very hands-on approach. This is not a remote relationship. There is a direct interface between the business owner and the private equity partner and the relationship is accommodating and flexible.

Another benefit that private equity financing offers is that the incoming partner plays a business mentoring role that adds significant value. The private equity partner goes way beyond merely attending quarterly or monthly board meetings. Parties can interact every week or even every few days, depending on the size of the business and how advanced it is. Private equity investors are closely involved with business strategy, corporate governance and organisational development. In emerging markets in particular, a key function of the private equity investor is the identification and recruitment of senior management.

Private equity partners are more patient than banks and have a long term view, typically between four to seven years. In general, the investor assists the business as it grows, watching out for potential pitfalls and addressing them sooner rather than later. The fortunes of the business are followed extremely closely and any bad news does not come as a surprise.

Developing businesses considering all sources of capital need to be aware that although there are no regular financing costs such as interest like on a bank loan, in the long run private equity can be more expensive than loan finance. In this case, an owner or founder is giving up an equity interest and foregoing some portion of capital appreciation.

Despite their long time horizons with respect to their investments, all private equity financiers have an exit strategy where they will sell their investment at some point. In order to raise new capital to invest in other growth businesses, the investor must return capital to their shareholders or limited partners. The exit strategy can be realized through a stock exchange listing, a sale of the whole company, or a sale of the investor’s stake to a new equity partner.

Is Private Equity Right for You?

Private equity is not suited to those owners who are satisfied with the lifestyle, income level and wealth creation in their current business. These "lifestyle entrepreneurs" can be terrific business people, but the growth expectations of new shareholders may clash with owner’s satisfaction with the business’ current results.

Further, a private equity investment without a controlling shareholding is usually not appropriate for most family-owned operations. As blood is often thicker than money, family loyalties, sibling rivalries or inheritance issues often make this an investment area with too much potential for conflict. However, when a founder or owner is looking to bring in professional management while reducing his or her equity stake in the business, these are often strong investment cases for the right private equity partner.

New entrepreneurs with limited track records will struggle to find funding from banks or private equity providers. Private equity managers usually prefer to see businesses that have reached a certain turnover level. Even if they are loss-making, they’d like to see the company to have achieved certain operating or revenue milestones before they will consider investing.

In summary, a private equity investment would appeal to those who are highly ambitious and energetic and want to create substantial additional value in their businesses. There has to be chemistry and a commonality between all shareholders and managers. And, finally, the original founders must realise they will no longer be running it only for themselves - other parties are now involved, but those parties also want to maximize the value of the business.

Key questions for entrepreneurs considering private equity:

• Are you convinced your business could be substantially more valuable, even though it might take more effort on your part?
• Does your industry have attractive characteristics in terms of growth nationally or internationally?

• Is capital a substantial constraint to growth?

• If you raised more capital, do you have a detailed plan to spend the money judiciously?

• Do you have the management capability and depth in your business to realize your aspirations?

• Are you a good listener and can you work well with peers?

• Are you willing to own a smaller piece of a potentially much larger, more valuable pie?

If your answer to all  of the above is an unqualified "yes" please contact us on info@horizonequity.co.za.