Private Equity versus IPO versus Trade Sale – exploring funding and exit strategies for mid-market organisations.
There comes a point in most company journeys where discussions on funding reaches the board room table. Whether it’s working capital to fund expansion or the owner preparing to exit, there are numerous options for raising capital that scale up and established businesses should consider.
In Strive Capital’s latest article, we explore three of the most common funding or exit strategies, considering the benefits and limitations of each, to give you a head start when assessing which route is best for your company.
Private Equity Investors
For many up and coming and established businesses, private equity is a known source of funding that provides an injection of working capital and expertise, without relinquishing day to day control of the business.
Why business owners opt for private equity funding
Private equity allows the business to raise funds and gain strategic advisors and innovation without being bogged down with cost, risk and heavy compliance commitments that come with other sources of funding.
PE firms and their management teams share common objectives to create value for stakeholders and high overall returns for investors. These common goals can make it easier to grow the business, acquiring customers and ultimately achieve the strategic goal behind the funding.
Investors want strong management teams in place and so value your position and legacy in the company and seek for you to have an active role in the business going forward. If you are planning for exit, there are proven ways of preparing for this, maximising the short and long term value.
Private equity investors bring vast experience of running businesses with sound advice for good ROI that isn’t always as accessible with other sources of funding. And because many private equity firms focus their investments, they usually know your market, competitors, customers, suppliers, technologies, processes and what is required to scale your business.
Driving efficiencies including investment in technologies and the latest processes is often where private equity investors can add value to your company both in terms of funding and expertise. Reducing costs and increasing new customer acquisition is a win win that you are left to deliver alone with other funding sources.
Most PE investors are experts in M&A which can bring a new dimension to a business that has grown organically. This opens new doors for your company to lead market consolidation or expansion into new territories that may not have been available otherwise.
And finally, while you would be reducing your stake in the business, the conditions around the cash investment in the business can be less risky that other sources of funding. For example, PE funding as an alternative to bank lending and high risks loans.
Why businesses consider alternatives to Private Equity
While private equity having an active involvement in your company usually adds value, your ownership of the business is diluted with the stake the PE firms takes in the business. This is the decision business owners typically wrestle with the most weighing up whether retaining full control and going it alone versus having funding and expertise deployed into the business will generate the greatest return.
As part of the active role a PE firm will take in you company, they become involved in the operational and strategic decision making – for a business owner that has grown the company from the ground up, it is a cultural shift to embrace and you may have to deal with differences of opinion when reviewing key areas of the business.
A good fit? Because PE firms often focus on sectors and markets, you need to qualify if a potential investor has the experience to add value to your business. An investor stepping outside their wheelhouse may struggle to realise the value and returns promised during the early phases of the engagement!
Become a publicly listed company.
Once a company reaches the quantitative and qualitative requirements – financial, growth potential, executive team in place, audit ready and so on – to list on a stock exchange, it is a natural consideration for an executive team seeking to secure funding for expansion in support of the business plan. There are numerous considerations – advantages and drawbacks of listing the company.
Why businesses go public:
The number one reason for becoming a publicly listed company; It is usually the quickest way to raise significant funds for the business. If the company also intends to grow through acquisition as well as organic growth, the funds can be used to acquire complementary businesses, further increasing the market value and standing as a result.
In addition, being a listed company is held in high regard and likely to further increase reputation and exposure which brings numerous benefits including sales, investment and attracting high calibre talent that the business may not have had access to.
Why businesses stay in private ownership:
Despite the cash benefit, there are drawbacks to consider when weighing up whether to list publicly or not.
Going public is expensive; the preparation of financial, accounting and strategy documents is costly with legal, sales and marketing, and other costs on top.
Public means public – your financials, tax and accounting information as well as general business information will be made public, eroding the privacy and control you enjoy as a private company.
Alongside the loss of privacy, overnight, you become subject to regulatory and compliance obligations and regular reporting to the market on the performance of the business. The frequent legal and business documentation can become a significant burden and distraction for the executive team.
Founders and entrepreneurs are also often frustrated through the lack of agility. As a public company, compliance obligations requiring announcements to the market when certain changes are planned, can make the business less nimble to things like shifting market conditions, technological advancements, or competitor activity.
Perhaps the most significant consideration however is the business case for going public that weighs the benefits against the risks. History is abounded with success stories and failures – you may even be able to study examples in your own marketplace. While successful IPOs are numerous, planning and timing is critical if the business is to avoid a luck warm response from the public, lower than anticipated revenue, and a low share price all of which will do nothing for the reputation of the business or its prospects.
Trade sale
Trade sales where the business owner sells to another business often operating in the same market are popular if you are seeking to raise the highest amount possible and exit the business.
Why businesses choose a trade sale:
Public investors are generally more cautious when valuing a company and so selling via a trade sale may generate a higher return more quickly.
Due to the nature of the trade sale, the owner has the option to exit the business after a handover or earn-out period and pass the running of the company to a new management team. This is attractive you wish to raise capital for other ventures.
Trade sales can be executed more quickly especially if the buyer is a similar business themselves – the due diligence process before the sale is likely to take less time.
If you will hold shares in the acquiring company, a successful purchase and future strategy may increase the reputation and value of the company which again will be attractive.
Disruption is a significant factor to consider as well. Ensuring a smooth transition with the least amount of disruption for customers, partners and employees alike, will avoid potential attrition. If the acquiring business is already familiar, disruption is easier to minimise.
Why business avoid trade sales.
You hand over the keys. While attractive to some, many business owners in our experience fully intend to retain some (active) involvement in the company. With a trade sale it can be more difficult as the acquiring business is likely to have their own plans for the business and the plans don’t always involve the current management team.
There is an immediate loss of control – you will have made the important calls, steering the company up to this point and the cultural shift to no longer being in charge and having someone to answer to, can be challenging.
On top of this, the current owner may not agree with the future direction of the company and will face a decision to ‘fall in line’ or step away from the business. An eighteen month earn out with a management team you’re not gelling with isn’t going to be fun.
The executive team will know that their services will no longer be required in some cases and so the potential negative impact on performance and morale and how that filters down into the organisation, has the potential to negatively impact the business and customers.
And finally, if the sale doesn’t go ahead, company information and IP will have been captured potentially by a rival!
For further insights on scaling an established business, sign up to the series here.