What is a Private Equity firm?

Private Equity firms are financial investors who wish to obtain high returns by acquiring shares in companies with the potential to create shareholder value, and to do so they are willing to assume a higher risk than when investing in other financial assets with lower return potential.

These buyers expect the management team to manage the business well, so that the value of their shares will increase and they can sell for more than the purchase price. In addition to investing in equity, these investors may provide some of the debt needed for the acquisition and play a role in convincing banks to lend the necessary financial debt. These investors are usually specialized and experienced in buyouts, so they can be of great help to the management team in preventing and resolving problems.

After the acquisition, Private Equity controls and monitors the management through monthly reports and meetings of the Management Committee and Board of Directors in order to closely follow the development of the company. They are usually specialized investors with experience in acquiring companies, creating value and subsequently selling the companies, so they can be of great help to the management team in managing the companies. Financial investors are experts in selecting targets, negotiating and structuring sale and purchase agreements, negotiating debt with banks, designing a business plan that generates value, and selecting and incentivizing management. Once the business is acquired, they usually take an active role in managing the acquired business (hands-on approach), trying to assist the management team as much as possible in implementing the business plan.

When it comes time to sell the business (the exit), financial investors also play an important role in negotiating the sale and purchase of the business in order to maximize the capital gain.

In recent years, they have found that taking a hands-on approach (constantly assisting the management team) is more beneficial than a hands-off approach (just tracking results and holding board meetings), as it leads to better results.

Private Equity firms can have two types of activity: the purchase of shareholding packages via capital increase to finance the development of the company and the purchase of companies through buyouts. In Spain, the Venture Capital & Private Equity Association (www.ascri.org) has more than 200 members.

Private equity firms manage third-party funds (pension funds, investment funds, family offices, insurance companies, etc.) for a temporary period (generally 10 years). They usually have a certain degree of specialization by type of operation (buyout or development), size of investment, sectors of activity and geographical area.

In most cases, the companies in which Private Equity firms have a better evolution in terms of sales and profit growth, create more jobs and invest more than equivalent competitors; for this reason, public administrations favor the fiscal conditions of Private Equity firms as they invigorate and consolidate the business fabric.

Functions of Private Equity companies.

The following table shows the functions of private equity firms at each stage of the buyout.

Phase

  • Function of the Private Equity Firm

Pre-acquisition

  • Selecting suitable target companies
  • Selecting suitable managers 
  • Choosing the right time 

Negotiation

  • Negotiate with sellers
  • Participate in the design of the business plan
  • Negotiate and incentivize management
  • Negotiate with banks to obtain debt
  • Design financial and legal aspects of the acquisition

Post-acquisition

  • Control and monitoring of managers
  • Promote professionalization and focus on value creation
  • Participate in strategic decisions
  • Promote strategic alliances and acquisitions
  • Providing additional funds in case of need
  • Providing image and contacts
  • Renegotiate debt conditions

Output

  • Deciding on the right time for divestment
  • Finding and negotiating with potential buyers
  • Legal and financial implementation of the sale and purchase transaction

In the pre-acquisition phase, the Private Equity firm plays an important role in selecting Target companies in which strong value creation can be realized in four to five years. Moreover, thanks to their experience, they know how to evaluate the right management teams to carry out this strong value creation. Finally, the financial investor is constantly buying and selling companies so that he knows how to detect the right time to buy and sell. 

In the negotiation phase, the financial investor brings his knowledge and experience in negotiations with sellers, managers and banks. Negotiations with sellers are always unique, complex and difficult to close, so they require a lot of experience. With the managers, they design the business plan and negotiate the conditions to be partners in the future, so that the interests of both parties are clearly aligned. Finally, they play an essential role in negotiating with banks and obtaining the necessary debt to acquire the company. In addition, Private Equity firms are the ones who carry out the financial and legal design of the operation.

Generally, after the acquisition, to assist in the development of the company’s business plan, the private equity firm controls and monitors the acquiring managers through monthly reporting and management committee and board meetings. Other contributions may include: injecting additional funds in case of need, whether due to growth or crisis; negotiating with banks to obtain more debt or renegotiate conditions; establishing rigorous and reliable financial reporting systems; participating in all relevant decisions (investments, divestments, hiring of key personnel, decisions on new products and markets, etc.); facilitating contacts with potential clients, public administrations, suppliers and partners; and assisting in the acquisition of companies or strategic alliances to grow the firm.

Finally, the Private Equity firm decides the timing of the exit and plays an important role in finding potential buyers, negotiating the terms and conditions, and defining the legal and financial instrumentation of the sale and purchase agreement. The main exit formulas are to sell to a strategic competitor or to another Private Equity firm. In large transactions, the company can also be floated on the stock exchange.