PRIVATE EQUITY - PROCESS

If you’ve heard of stocks - you probably know that you can buy them off a stock exchange. This is the world of public equity, where the public can buy and sell shares in a company. If you’re familiar with IPOs, then to put it simply… before a company goes for an Initial Public Offering (IPO) it WAS a private company (duh!).

Private Companies are private - the information concerning their working, their financial accounts, their processes are all ‘private and confidential’ and may not be readily available from a site like ETrade or Edgar Online, packaged in a standard format for you to digest and make an educated ‘guess’ at what it’s worth.

And because they’re private - buying them is not so easy. Only select investors can buy enough equity (shares) in them to have decent stake. Usually these are investors with a lot of cash - A LOT. We call them High Net Worth Individuals (HNWI). However, that shouldn’t stop you from understanding more about Private Equity, should it!

There are various reasons why a private company may want to approach a Private Equity Investment Firm, but two of the strongest reasons are -

1.   they have grown by themselves so much that they require a fresh injection of funds from outside to grow further and reach higher economies of scale or;

2.   they believe in getting prepared by working alongside a professional team who will provide the equity finance, share ownership (and thereby risk and reward) and ultimately guide the company to a IPO.

As any well run organization will tell you, you must have a process. And so do we (I speak for the PE profession)…

The Private Equity Process in 7 Steps:

1.   Deal Origination (Deal Sourcing)

2.   Due Diligence

3.   Deal Negotiation

4.   Deal Closing (Acquisition)

5.   Post Acquisition Monitoring

6.   Exit (IPO, Trade Sale or Buy back)

7.   Repeat.

Deal Origination or as some call it ‘Deal Sourcing’ is how we get our deals, a potential deal can either come through a company owner approaching us or from an intermediary who will try to bring both parties (Company and Deal Maker) to close the deal. In some cases, we may just approach companies who are expanding fast and wish to grow further. In a year, we come across hundreds of potential deals - but only a few are selected.

Due Diligence is what you could call ‘doing your homework’. Before starting detailed negotiations, we try to make sure everything is fair and square. Although Auditors and Consultants are appointed to conduct the Financial, Tax, Legal and Technical Due Diligence - we also work side by side to understand the target company and its industry better. All the information collected at this time, is then used during negotiation.

At the Deal Negotiation phase, we set out the terms and conditions (covenants, representations and warranties) and other deal terms that define (or make the deal). Contracts such as Investment Agreement, Share Purchase Agreement, Management Agreement, Advisory Agreement etc are drafted to include all items that put the deal together.

Deal Closing is probably the easiest part but also contains an element of risk. It’s the conclusion of the deal, the signing of all Agreements and transferring funds* from the buyer to seller, conducting other administrative functions (usually done by a separate entity) like updating any articles of association etc.

* So where do those funds come from? Well, there are two routes - the Fund route or the Private Placement route. And this is where the element of risk can step in. Most private equity firms have a Fund, that calls upon its HNWI to bring up money as committed earlier to fund these acquisitions. However some firms choose to place (sell) a stake in the ownership of the acquired company to certain individuals who might wish to participate only in a specific sector - what we commonly call the private placement. We do through this Special Purpose Vehicles (SPVs) that are nothing but legal entities to hold our stake in the company.

Post Acquisition Monitoring requires the Deal Team (those who have worked on putting the deal together) to closely monitor the company, both from an operational and financial point of view against the expansion plan and budgets that were setup earlier by the company. Improvements to business, from Corporate Governance, Financial Reporting, and Information Flow to Strategy are made at each level through either the company’s management or its board (where we have a seat).

As the company matures (usually after 2 - 4 years) with the presence of the Deal Team, we prepare it for an  

Exit - either an IPO or a Trade Sale (sale to a larger party, multi-national or conglomerate) or in rare cases a Buy Back by the owners. By this time, the company will have grown quite a bit with still plenty of room to grow further. (There’s a saying, in a deal - always leave something extra for the person buying - it makes everyone happy.)

And once we’ve exited the company, we return our investors money with the profit we gained for them after taking our fees for all the effort put in the above process. Then… we just repeat the process, albeit with a greater appetite for investments.