Time to Find a Growth Equity Partner? Read this first.

Private equity growth funds are vital players in the investment landscape, providing capital to businesses poised for expansion. However, attracting equity investment from these funds is not without its challenges.

Understanding the main issues can help companies position themselves more effectively for potential investors. In this blog, we’ll explore the primary hurdles businesses face when seeking equity investment from private equity growth funds, and what founders can expect.

Demonstrating Strong Growth Potential

Private equity funds are primarily interested in businesses that show promising growth trajectories. This means that companies need to demonstrate not just current success, but also a robust plan for scaling.  Typically, this involves funds being able to believe that:  

• The business is strong and has been performing with a consistent and clear record of profitable growth: Investors often look for past performance metrics as indicators of future success, and startups or companies without a strong track record may struggle to gain initial interest from funds.  Funds tend to approach, or gate, investments on the basis of revenue and EBIT status; positive revenue and EBIT companies on an “LTM” – Last 12 Months – basis will attract most attention.  For EBIT negative companies which are investing heavily in building the scale (for example SaaS), it will be important to show that the sales engine works well and is attracting a diversity of customers. 
• The company has an edge against its competition: In crowded markets, distinguishing oneself can be difficult. Companies must articulate a clear unique selling proposition and present compelling data on market size and growth potential, and be ready to prove that they have an edge in either product or solution design, or go-to-market.

Funds will conduct thorough market research and competitive analysis before investing, and so good raise processes clearly highlight the scalability of the business, are honest and introspective around the numbers and articulate a well-defined growth strategy.

Its (Mostly) About You – the importance of the Management Team

Private equity investors often emphasize the importance of a capable management team, and founders that have a tireless ambition to see the company achieve its true potential. Growth funding does not “fix” problems – it should be viewed as a partnership model to take the company to the next level.  Funds, whether at gating stage or at IC level, need to believe that the leadership can execute the growth strategy and adapt to challenges.

Key points of differentiation include:

• Experience and Track Record: A management team lacking relevant industry experience or a proven track record can deter potential investors. Conversely, management tend to be considered “investable” if they have a strong track record of operating at scale, have a growth mindset and are open to collaboration with new equity on how best to achieve targets
• Team Dynamics: Investors often assess how well the team collaborates and if it has the right mix of skills and expertise.  Pre-money boards and management must show alignment and show confidence in each other, if new equity is to feel comfortable about investing.  Growth equity will tend to avoid turnaround situations where Boards and management are in conflict on matters of strategy or execution.

Ensuring Financial Transparency

Growth equity is not a sale; it is a partnership.  Private equity growth funds need to know what they are working with, and term sheets will always require a period of due diligence to provide comfort on matters that seem unclear.  There is therefore no point obscuring information ahead of receiving offers – rather, the right mindset is to provide comprehensive financial information to allow the fund to assess any potential investment accurately. This transparency is crucial in building trust and confidence, and preserving pre-exclusivity valuations.

For many businesses, a lack of transparency can be unintentional.  Many growing businesses struggle with financial reporting, especially if they lack sophisticated accounting systems or expertise.  For those with up to date accounting and systems, often a forward looking model will not exist and this can be a valuable first step in defining the future growth pathway. 

Companies should expect that potential investors will scrutinize potential risks, including any hidden liabilities that could impact the valuation, during a “red flags” period either prior to or in the early stages of exclusivity. Where information is not available, honesty must take its place.  Providing clear, detailed, and accurate financial information, or being open to where this doesn’t exist and why, can instill confidence in potential investors and allow them to focus more on areas where they will need greater detail before the deal closes.

Valuation

Valuation is one of the most contentious aspects of securing equity investment. Both parties—business owners and private equity investors—often have differing expectations for completely reasonable reasons. 

On the company side, it is natural to love your own business and to see the raising process as a validation of all of your years of hard work.  Funds often report that founders almost always overvalue their businesses based on emotional attachment or inflated projections, which can deter interest from investors. Engaging a financial advisor to assist in determining a fair valuation based on market benchmarks and financial performance, and listening to that feedback, is crucial. This can facilitate more productive negotiations prior to bid, and assists in keeping as many interested parties in a process as possible.

Its worth bearing in mind that investments are quite risky for funds.  While DD will provide a level of comfort as to the financial and legal architecture, and possible market success, ultimately an equity investor is an outsider to the day to day problems and solutions that make a business work.  An incoming investor wants to pay a fair price, genuinely contribute to the growth of the business and then share the proceeds of any later sale with the existing shareholders and owners.  Founders should always try to remember that the upside of growth investment is a smaller share of a much bigger business. 

How will life change for me?

Yes - things will change, but thats to be expected. As the new shareholder agreement is drafted, new classes of shareholders will likely be drafted, new rights around future sale events will be included, and board/management decision making will be agreed.  These changes reflect the need for the new investor to be able to control the potential downside for their investment – ie in a circumstance where management manifestly do not perform, investors will need to be able to preserve their investment through a range of provisions to turn the situation around. Founders should also expect that investors will want exit control – the right to control a sale event.  Often this is non-negotiable as fund mandates require it. 

Finding the right partner is more important than finding the right price, and this will become evident in the lead up to transaction close, and then the way that the new Board and management work together post the completion date. In most cases, provided the right partner is chosen, this can be a time of true liberation for management teams who now have the funds to make their vision a reality.  The best equity funds are true partners in growth.

Conclusion

Attracting equity investment from private equity growth funds is a multifaceted challenge that requires a strategic approach. By addressing these main issues—demonstrating growth potential, building a solid management team, ensuring financial transparency, navigating valuation and negotiations, and understanding investor perspectives—businesses can enhance their attractiveness to private equity investors.

By proactively tackling these challenges, companies can not only secure the funding they need for growth but also forge valuable partnerships that can drive their long-term success.

Looking for a growth equity partner?  Message one of our team for a meeting or to continue the conversation.