First, let’s do a quick comparison:
“Strategics” are loosely defined as companies which typically operate in your sector and which may be willing to invest in your business. In addition to obtaining a commercial advantage from the relationship, this can secure a preferred opportunity to acquire your business in the future. Having a strategic partner on board usually provides stakeholders with an exit path, but care must be taken to ensure a fair and well-defined exit mechanism. Some large companies have formal investment departments with well-defined acquisition strategies.
Private Equity funds look to acquire businesses to dispose of them at a healthy profit within a limited time frame. They look for historically profitable companies that they can leverage as much as possible to streamline, grow and/or consolidate in order to increase their value. In order to do this, they must have a controlling interest in the business and will be closely involved in operations. The typical PE time frame is 5 to 7 years and exit mechanisms are pre-defined and tend be in their favor.
Family Offices look to invest longer-term money for the benefit of the families or individuals they serve. They are typically not interested in managing the business, nor are they willing to take high risks. Rather than profit on an eventual sale, their goal is to obtain a steady income stream. Like PEs, FOs look for historically healthy businesses but will not necessarily attempt to squeeze out cash to pay for leverage; as a result, they do not require control. Participation usually does not extend board level.
Delivering the Message
Despite the vast cash reserves looking for investment opportunities, fund managers have not relaxed their strict standards to deliver the best possible returns with the least possible risk. Investors are very selective and you must compete for “capital attention”.
Strategics and FOs are flooded with investment proposals and many even prefer to find opportunities themselves rather than accept calls; “don’t call us, we’ll call you” is a prevalent practice. PEs, on the other hand, screen heavily for minimum revenue and profitability levels. Also, as there are fewer Quebecbased PEs, you should consider widening your search; bringing in outside competing investors could result in a more generous valuation.
These three investor types generally prefer placements above $5 to $10 million; anything lower does not “move the needle” to warrant the effort.
If, and when, you do get through to a fund manager, his or her attention span will be short; you have to deliver your message quickly and clearly. What you need is an effective pitch (see sidebar). A good information memorandum is still essential to the process but it should not be used for the initial approach.
Showing how your investors are going to make a return is key to landing a deal. Similar to selling your company outright, you have to rationalize between what you wish for and what your company is really worth. The most common valuation methods are based on your recent historical results (few investors will consider forecasted future results) multiplied by a factor which takes into account similar transactions, your size, your growth potential, the sector, etc. In most cases, both parties come to similar valuations and if they don’t, independent 3 rd party valuations can help.
In order to avoid uncertainty, both parties should agree to pre-define the exit mechanism. Most often, it should mirror the entry mechanism by using the same multiple. Always keep in mind, however, that while a high valuation at the beginning can minimize dilution, the same value mechanism at exit can mean an expensive buy back or may restrict salability.
Choosing the Right Partner
Understanding the type of investor you are dealing with and discussing future day-today management expectations are important starting points. Topics usually discussed at these meetings would include:
- What latitude will I have on capital expenditures, on hiring, on acquisitions?
- How will you finance this acquisition and what will be the future leverage?
- Who would I report to and who will I be working with?
- Who are your financial backers?
- Will there be management fees?
- What experience do you have with companies of my size and sector?
- What are you offering beyond capital?
- What is your average time to close?
- Can you provide references I can talk to?
Cafa has closed several transactions over the years with these three types of investors. We would be glad to share our experience on our successes and failures.