Texas Business Dispute Blog

Monday, June 13, 2016

Swimming with the Sharks (Part 1): Attracting Private Equity Investment in Your Business

By:  Ladd Hirsch (Dallas)

For years, use of the term shark in a business context referred to unsavory characters such as shady lenders, sketchy lawyers and unscrupulous business people.  More recently, the success of the hit reality TV show “Shark Tank,” has given sharks a Hollywood make-over, and a more positive image.  The Shark Tank show features small business owners as contestants who present their needs for capital to a panel of rich investors (the sharks), including Dallas Mavericks owner Mark Cuban.  Larger companies also need access to capital at times to fuel their growth, and this Post focuses on the ways business owners can make their companies attractive to private equity investors (the sharks).

1. Be Ready to Show High Growth Prospects

If private equity (the “PE”) firms were satisfied with low-yielding investments, they would buy low risk bonds or mutual funds rather than investing in private companies.  Instead, most PE firms are looking for high returns on their invested capital.  For this reason, business owners seeking a sizable capital investment from PE firms need to present their company as a growth story. 

Although private equity investors are attracted to companies that show substantial actual growth in the business, a high growth rate may not be essential if the business owner can project realistic growth prospects by demonstrating that the investment will unlock unrealized growth potential.  The company’s growth story will be compelling when the capital to be invested will facilitate the projected growth.  For example, if the PE firm’s funds are used to create additional production or open up new markets where a strong demand for the company’s goods has been shown, this use of capital provides a persuasive basis for investment.

2. Focus on Scalability as Well as Growth

Closely related to growth is the concept of scalability. Growth rate is just one business metric, but PE investors are just as concerned with the company’s ability to substantially grow the volume of its revenues over time.  In the public company context, Starbucks provides a great example of scalability.

Starbucks increased the number of its stores at a frenzied pace across the country, but it also realized that, at some point, the market became saturated with coffee shops.  Therefore, in order to continue growing its revenue, Starbucks began selling its coffee beans and a number of other branded products in regular grocery stores.  This expanded the Starbucks revenue stream, while still maintaining the company’s identity as a premium coffee supplier.

The Starbucks example presents business owners with this question about their potential for growth, which PE firms will be asking: what core competencies does the business have that will allow it to achieve significant growth, build its brand and still maintain its unique character?

3. Keep an Entrepreneurial Mindset at Management Level

Contestants on Shark Tank are looking for more than a capital infusion from the sharks, and they are right to be seeking business expertise.   One of the most important benefits of a PE investment is non-monetary.  A PE investment works best when, in addition to the dollars that are invested, the PE firm brings “knowledge capital” to the business.

The expertise that a PE firm can contribute in the areas of management, marketing, and creation of new sales channels are invaluable additions to a private company.  The involvement of a PE firm in the business does mean, however, that the business owner has to be willing to implement suggestions that the PE firm brings to the table.  A PE investment does not require the business owner to cede control of the company to the sharks, but if the owner wants to maintain maximum control and is resistant to suggestions from outside investors, this does not bode well for a successful partnership with a PE firm. A business owner who wants to maintain unfettered control over the business should be seeking debt from a lender and not entering into a long-term relationship with a PE firm.  

4. Become a Change Agent in the Marketplace

A business owner will have PE firms flocking to the door when the business operates as a “change agent” in the marketplace.  The old adage for creating a successful business is: find and need and fill it.  It sounds simple and it is.  Successful businesses are those that provide goods or services that meet a strong need in the market, and do so in a way provides the customers with a sense of satisfaction with the purchase.  Uber is just the latest example of this type of successful business.  In a market with many different taxi services available, Uber combined modern day technology (everyone has a cell phone) with a powerful need in many cities (transport without a car) creating a marriage that has produces consumer satisfaction. 

A business owner who fills a strong business need with creativity, efficiency and passion for delivering value can create a high growth business attractive to PE firms willing to provide the capital necessary to support its growth.  Focusing on making the business as successful as it can be is the best way to attract investors and to avoid becoming shark bait.


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