Private equity, when it’s interesting for startups and scaleups (I)

Definition and characteristics of the private equity industry

Private equity is a particular type of closed-end investment fund (not listed on the stock exchange). It consists of a medium-long term financial transaction in which a private investor invests his risk capital in private companies with strong growth potential, with the aim of enhancing them and then making a profit (disinvestment) through the sale of his share or landing on the stock exchange.

Difference with venture capital

Up to this point, private equity could be confused with
venture
capital
. Although with similar objectives and always being venture capital, they differ in strategies. Venture capital, in fact, is a financial operation that intervenes in the early stages (e.g. seed) of a startup, while private equity focuses on more mature companies.

Players in private equity

A private equity firm, on the one hand, invests On the other hand, it raises the capital of others institutional investors (banks, insurance companies, pension funds, financial holding companies and family offices) or qualified (very rich people) called Limited partner (LP) within a fund. The company that owns the fund is called the General Partner (GP), because it is responsible for the management and strategic decisions regarding the fund, while the Limited partners are only responsible for their own capital without an active role in the day-to-day management. PE funds identify from the outset the amount of capital to be invested, the duration of their business (usually less than 10 years) and their objectives. Funds are distinguished according to targets, i.e. the type of company in which to invest: for example, whether in a specific sector or by type of company based on the number of employees or turnover (large deals), if not in companies in crisis (turnaround of distressed assets).

Understand the concept of private equity and its relationship to business scaleup

The target company entering into private equity transactions must fall within the PE fund’s investment criteria and strategies . These companies thus have the opportunity to scale much more quickly through revenue growth and the injection of large amounts of liquid capital, without which they would spend more time, resources and energy. In addition, the GP offers its know-how in financial choices and logic, thus giving support to the founders or entrepreneur of the target company. Here, thanks to PE, it can reach the levels of a

scaleup

: companies that have raised (in the last three years) or have a turnover of up to 100 million dollars.

Role of financiers in the scaleup process of companies

When the company is at an advanced stage, new investments from private equity could enter, through operations such as
growth equity
– with the purchase of shares -,
secondary buyouts
– with the purchase from other PE funds (i.e. funds that have already acquired the shares of a target company), and finally there are sector
funds
, often called industrial or technological, which make use of a team, advisor, network or know-how specialized in a certain sector.

How Private Equity Supports the Growth of Startups in Development

You often hear the claim that private equity differs from venture capital because it doesn’t invest in startups. Attention: the correct statement is that PE invests in startups but in the most advanced stages of them, when the startup has grown with the transition from micro-enterprise to SME or large company, thanks also to the contribution of venture capital. In fact, private equity enters a startup through
growth equity
operations, for example: when the startup is at an advanced stage (after the seed phase), new investments could enter from Private equity, which buys the company’s shares from venture capital (in this case the VC makes an exit operation), until then in their possession. This is how the company has the ability to scale faster and become a scaleup.

Selection criteria for private equity investments

Once the private equity fund has been created, a capital raising phase follows. This phase has a period and, when the collection is defined as closed, no one will be able to invest in it anymore, not even the LPs themselves. After collection, a phase of research of the target companies takes place, often carried out by well-qualified advisors, who, having identified the companies, through due diligence will understand whether they reflect the criteria of the GP.

How Private Equity Lenders Evaluate Investment Opportunities

Due diligence is therefore a real CT scan of the company: it can be legal, financial, accounting or industrial. If the result is positive, once the shares of the company have been acquired, the private equity operator will accompany him for the following years in the decisions to improve the company and where, perhaps, the entrepreneur would not be able to take alone, for example in the choice to
internationalize
, the creation of a newco, M&A; or thanks to its network in the financial world, the PE is able to reduce the company’s debt by renegotiating interest rates and conditions on the loans that the company has in place with banking institutions.

Benefits and Opportunities of Private Equity in Business Growth

Private equity in an agile way provides companies with liquidity and useful skills for their exponential growth. But it is not limited to this: it offers support and in some cases guides the target company in strategic and financial choices throughout the duration that precedes the divestment of the fund.

Operational strategies to make the most of private equity investments

Lately, many private equity operators are breaking the classic schemes and structures of the closed-end fund: they invest with a
permanent capital
logic (without a predefined maturity), i.e. they offer companies increasingly patient capital suitable for supporting long-term growth with a very industrial and value-creating approach over time, thus without respecting the 10-year limit. But PE strategies can be different based on the needs of the market. In recent years, PE funds have sought to create a better balance in their investment portfolios by inflating investments in countercyclical sectors. On the other hand, some have accelerated their exit strategies, while others have become more cautious in assessing target companies. It should always be borne in mind that the initial strategies differ according to the target company to which the PE operator wants to operate and for its phases:

• In an early stage , the intervention strategy is applied through venture capital operations, which include seed capital funds, startup funds, VG capital funds, IPOs. Following these strategies, minority stakes in small and very young companies are acquired. The high risk of the investment is due to its high return, both of which are given by the potential that was completely untapped at the time of the investment. Although the initial capital invested is often small, it is balanced by the underwriting of
  stage financing
  : financing that is disbursed gradually upon the achievement of certain objectives.

For these reasons, initial PE investments tend to be limited in size for equally small portions of companies’ capital.

• The strategy of globalcapital or growth financing is to invest in fast-growing, well-structured firms to help them grow faster: firms with significant operating revenues and profits but insufficient capital to pursue transformational programs into larger, more advanced firms in emerging markets where firms do not have easy access to capital from banks or from the stock and bond markets. The strategy to be followed is that of the b
  uyout
  which is divided into: the
  everage buyout
  (LBOS), the m
  anagement buyout
  (MBOS) and finally the m
  anagement buyin
  (MBIS).
• The investment strategy ofistressed-debt and turnaround is the one that concerns the phase of decline of a company. There are two different approaches to this strategy: the cyclically-orientedapproach (the EP buys the company’s debt) andthe approach ( the EP negotiates debt restructuring in order to invest new capital and take control). They involve companies in a state of financial stress due to excessive debt or in a phase of declining revenues; Companies that may therefore have an unbalanced capital structure or that operate in an industrial sector where there are strong threats.

Strategic partnerships between investors and businesses for accelerated growth

Two or more private equity firms may partner to acquire a target company (
co-sponsor deals
). This partnership can take place for several reasons:

• increase the size of the investment
• Diversify your risk
• Sharing skills and resources

Co-sponsor deals can be structured in several ways: private equity firms can create a new investment fund for the deal. Otherwise, they can use investment funds that already exist. Co-sponsor deals are a common strategy in private equity. In 2023, about 30% of private equity deals were co-sponsor deals. In 2023, there have been several, such as that of the Blackstone fund that partnered with the Carlyle fund to acquire the financial services company Aon. Or in 2022, with the KKR fund partnering with the Permira fund to acquire the telecommunications company Telecom Italia. And in 2021, private equity fund CVC Capital Partners partnered with private equity fund Advent International to acquire luxury firm Tiffany & Co. (Photo by m. on Unsplash )

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