Monday, 19 December 2011

Specialized Funds for Unique Needs

I have noted before that there are over 40,000 private equity funds in North America ranging from individuals to multi-billion dollar funds such as Kleiner Perkins Caufield & Byers, Draper Fisher Jurvetson, General Catalyst Partners, and Sequoia Capital. 
If you have a business that is generating about $1 million in EBITDA or greater, then there is a good chance there is a fund out there that may have an interest, and probably investments, in your space, resulting in the possibility of a good transaction.  Even companies at break-even or in a loss position can find interest from the private equity sector, however, in these cases they are likely to be opportunistic or vulture funds which sometimes results in the sector being painted with a broad brush.  In general, private equity is smart money that can bring more than dollars to the table and, as such, can be a good partner for the right company.
The most ad-hoc type of fund is a special purpose acquisition fund, where accomplished individuals are able to secure backing, typically from high net worth individuals, in the $5 million to $20 million range to acquire a single company.  This is a financial buyer in the purest sense as there are no synergies to be realised, however, usually a board of directors is formed by well heeled and well connected partners who can then help with business strategy, customer leads and further acquisition financing.
Beyond this one-off type of fund there are established venture capital and private equity funds.  In my experience venture capital investors typically take a substantial minority equity position and look for investments that can return 5x to 10x (i.e. if they invest $1 million, they target a realization of $5M to $10M in a sale or IPO exit).  VCs don’t look to achieve their goals by acquiring additional companies in the space but rather by betting on, and working with, the expected winner in the space.  Private equity on the other hand, quite often seeks 100% ownership and will then continue to look for add-on or tuck-in acquisitions to grow and increase the market power of its investments.  Private equity comes in many varieties including Leveraged Buy-Out (LBO), Growth Capital, Distressed and Mezzanine Funds.  It is not unusual, given that these funds often have a finite period within which to raise money, invest it, and return it to investors, that one fund’s exit is another’s entry. 
An example of a unique equity group is Argosy Partners.  Argosy Partners manages the Shotgun Fund® and the Succession FundTM.  The Shotgun Fund® will purchase common shares from departing shareholders when a shotgun clause or buy-sell agreement has been executed (i.e. your business partner offers you $5 million for your half of the business and you have 30 days to decide whether to sell to him or to buy him out).  Because of the time constraints in such circumstances, The Shotgun Fund asserts it can close a transaction in less than 5 days of first making contact.
The Succession Fund purchases shares from shareholders that are looking for liquidity and want to take "Chips off the Table".  The Succession Fund typically partners with continuing owner-managers who do not want to put their business up for sale prematurely, and who are reluctant to use significant leverage to accomplish their shareholder realignment objectives. 
If your view of private equity is that they will only buy companies at a discount, it may be time to take another look.  Private equity can be a good option for entrepreneurs looking for a variety of value enhancement or exit options.

Derek van der Plaat, CFA has worked in private market M&A for more than 20 years and is a Managing Director with Veracap Corporate Finance in Toronto.

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