Finding the Right Equity Partner: What Every Founder and Owner Should Know
Editor’s Note: This is part one of a three-part series.
At various stages in a company’s life, its owners consider bringing in third-party equity for the purpose of growing and/or exiting the business.
Finding and selecting the right capital partner can make a significant difference in the achievement of the owners’ ultimate goals. In this three-part series, I will outline important variables founders and owners should consider when selecting an equity partner.
Part one explores the core reasons an owner might pursue an equity partner. I also discuss the value and benefits the right equity partners can bring to the table that extend beyond capital. These benefits are often more valuable than the capital itself.
The second post of this series will delve into the history of private equity and venture capital and demonstrate how a better understanding of this history can help founders and owners achieve their goals.
The final post of this series will offer straightforward, pragmatic advice and guidance for founders and owners. I’ll outline the key qualities and characteristics that companies should look for when choosing an equity partner, including advice on how to prepare and approach that choice.
Part One: Why pursue an equity partner (and what can they bring beyond capital)?
Business owners seek external equity capital to achieve objectives and goals. These objectives and goals can be personal or company-related, although frequently they are a combination of both.
Even if owners are considering a buyout (e.g., selling their company), they are wise to consider a growth equity partner and the option of retaining capital in the company. The chart below illustrates where growth equity falls along the spectrum between venture capital and buyout capital.
Growth capital is generally used in proven and profitable companies to help them pursue top-line and bottom-line expansion (organically and/or through acquisitions). There tends to be a blurring of the lines between late-stage VC and growth equity since they are both growth focused.
At pePartners, we work with companies along this entire growth spectrum (including venture, capital, private equity, and mezzanine debt).
As the slope of the revenue curve illustrates, owners considering a 100 percent exit should weigh the upside of retaining equity in the business and seeking a capital partner with the expertise to help the company maximize growth going forward.
The variables that go into the decision to bring in a growth equity partner fall into three primary categories: (1) resource constraints, (2) risk mitigation, and (3) reward maximization.
Most business owners are acutely aware that capital is a finite resource.
Aside from owners’ contributions, internal capital is typically generated based on what customers are willing to pay for one’s product or service relative to the cost to produce that product or service (i.e., cash flow generation).
External capital is often needed to pursue growth opportunities that will maximize value. Without covering all the variations, most external capital comes in the form of debt, equity, or some combination of debt and equity, such as convertible debt. Aside from pursuing an exit, owners seek growth equity to pursue opportunities that banks and lenders may consider too risky to finance.
The need for external capital or the desire to exit is often an owner’s primary focus in seeking a capital partner. However, importantly, capital partners can provide more than just capital.
Equity providers can bring additional resources that help companies thrive and business owners achieve their short- and long-term goals. In fact, the intellectual capital and strategic value that the right partner can bring to a company is often more valuable than the capital itself. With the right growth equity partner, owners not only gain resources, but also can reduce risk and increase rewards.
Having most of your finances and energy devoted to your company means having all your eggs in one basket (in a multitude of ways). Growth equity enables owners to mitigate risk through asset diversification (i.e., takes “chips off the table”).
Aside from asset diversification, many owners are ready to devote attention to other interests. At pePartners, we work with a number of owners who have become involved in other ventures (both commercial and philanthropic) and have groomed others to run their companies. Selling part of their company reduces financial risk and creates incremental opportunities.
Even for an owner that stays fully engaged in the core business, bringing in a strategic capital partner can reduce risk by opening up the company to new ideas, new product lines, and complementary acquisitions.
Financial theory tells us that, generally, there is a positive correlation between risk and return. In other words, taking greater risks generally results in higher returns and taking lower risks results in lower returns.
When an owner sells part of their company to a growth equity partner, however, the lower risk through diversification often does not result in lower overall return. With the right equity partner, an owner can both reduce risk and increase reward by amplifying growth beyond what the owner could achieve alone. In other words, the owner has a smaller piece of what becomes a much bigger pie. In fact, when an owner is “all-in,” he or she might avoid taking potentially intelligent risks. Adding the right partner who has capital spread across multiple companies can create a win-win risk-reward profile for all stakeholders.
Here are ways growth equity partners frequently help companies “expand the pie”:
- Product expansions
- Add-on acquisitions
- Investment in capital equipment
- Technology investment
- Other value-added operational expertise
- Additional industry connections
In many, if not most industries, growth and technological advancement has become a competitive imperative. If a company is not evolving and growing, then it is likely falling behind. When looking for an equity partner, owners should evaluate how a potential partner has helped their portfolio companies grow and expand.
Growth can also have significant cultural value within a company. Growth enables companies to continually challenge and engage their best people. Keeping employees challenged and engaged is especially important in today’s fluid and tight labor market.
The following video clip of Steve Schwarzman, CEO and co-founder of the private equity firm The Blackstone Group, illustrates this point.
For more thoughts on leadership and employee engagement, have a look at this guest post from Jennifer Oertli of Radiant CX.
Partnering with the right venture capital or private equity firm can drive enormous value for a company and help founders and owners achieve their objectives and goals. Given the strategic value and reward the right capital partner can bring, owners thinking about a full exit would do well to consider keeping some skin in the game. In the next two posts of this series, I will explore the “why” and “how” of finding the right equity partner.
Martin M. Myers is managing partner and founder of Saint Louis-based pePartners.Martin’s 25 years of experience includes executive and management level positions at both startups and top-tier financial institutions, and a client roster of leading global private equity firms. For additional information, contact him at mmyers@pePartners.net or follow him on Twitter at @martinmmyers.