On Private Equity investors

If a fund or other investor enters my company, what interest do I pay?

Answer: No interest is paid. An investor is investing in share capital, not making a loan. He becomes a shareholder who enjoys the same rights as the other existing shareholders in the company.

OK, I understand that an investor is a shareholder (not a lender). So what dividend does he expect?

Answer: Typically, private equity investors do not expect dividends during the period of their investment. A private equity investor is looking to invest in companies with significant growth opportunities require additional capital. They would in fact be surprised if a high-growth company were paying a dividend, since such companies normally need to retain financial resources for reinvestment, not pay them out in dividends.

An investor is looking for financial return in the form of share price appreciation. This return is realized in cash terms at the time of exit.

Does an “exit” means the investor wants to leave the investment?

Answer: Yes, eventually. The logic of a financial investor is that he will want to sell his shares at a profit at some time in the future. Unlike a strategic investor, he is not investing forever. Normally, an investor will have an investment horizon of 4-5 years, but this is flexible based on the industry and the exit possibilities. In fact private equity investment periods have become shorter.

Where does the “exit” requirement of an investor leave me?

Answer: This is precisely what is discussed before an investor enters the firm. Based on a common understanding and commitment to the company’s medium term strategy, an “exit” plan from the investment is discussed. One possibility is that all shareholders sell to a Strategic Investor; another is that the company is listed on a Stock Exchange; a third possibility is that the (original) company owner buys out the shareholding of the investor at some market price which is to be determined in an objective manner at the time of exit (i.e. an independent consultant values the shares).
These issues are recorded in a Shareholders’ Agreement, which is a legal document binding the shareholders. A firm of advisors, like Osprey, helps negotiate such a document.

Which are the key things an investor seeks? Prior to exit, is it necessary to sign a contract? If so, for what period of time?

Answer: This depends on the particular circumstances. The Shareholders’ Agreement is critical in defining the major conditions an investor expects in order to protect his investment. They typically serve to ensure that the new investor ranks “pari passu” with the owner (i.e. sharing of risks in proportion to their shareholdings) and that there is commitment to implementing specific strategic actions (as previously discussed and agreed) to grow the company’s value.

Exit conditions are also mutually agreed in advance. For example, an investor can agree not to sell his shares to a third party without offering them to the company owner first (right of first refusal) or to sell his shares together with the company owner in proportion to their shareholdings at the same price.

How does one select potential partners?

Answer: Provided the price at which they invest is acceptable to the company owner, potential partners are selected according to qualitative factors: what they can bring to the investment beyond cash (access to managerial skills, industry contacts, strategic advice), compatible management philosophies and values, expected timing and manner of exit. Osprey pays careful attention to the management of this custom-tailored selection process.

Do the funds have minimum or maximum limits on the (a) the amount they invest and (b) on the percentage shareholding they take?

Answer: Most funds have guidelines with respect to investment amounts per company, expected (minimum) returns and the desirable percentage shareholdings, which can often be a (significant) minority percentage. The key thing is they want to make sure that the founder/owners continue to be properly incentivized to grow the company value according to expectations. Funds do not seek to take over the management of the company. They invest because they are counting on the skills of existing owners/ management.

Do the funds buy existing shares of the business or newly-issued shares?

Answer: Typically, investors want to invest in a capital increase, since the new money goes into the company itself to finance its expansion (known as “cash in”). Buying existing shares (“cash out”) can be part of the deal, but this results in money going to the owner/founder and therefore not benefiting the company directly, so investors prefer to keep this to a minimum.

Do the funds invest in groups of firms with diversified business activities?

Answer: t is unusual for a fund to invest in conglomerates. There are actually few such companies which have the consistency of performance across all activities and therefore, an investor will want to focus on making a specifically-defined business or sectorial activity a success.

What are the conditions required by investment funds regarding staff retention and the contribution of the founder/owner?

Answer: There are no conditions a priori regarding employees. The fund will want to make sure that a company keeps its key employees and that overall staffing (numbers and skills) are optimal. Any improvements are agreed and implemented together with the founder/owner based on prior discussion. The fund does not interfere with the hiring policies of the company. They may assist in finding good candidates for key executive positions. The point is that as shareholders, the fund has a common interest, in partnership with the company owner/founder, to achieve the best results of the company.

As for recognizing the past and on-going contribution of the founder/owner, there are several possibilities: some of the founder/owners existing shares can be bought by the investor (in a “cash out” scenario); in addition to his shareholding, the founder/owner may draw an executive-level salary from the business going forward; there may be share option arrangements which benefit the founder/owner based on continuing success of the business.

Which are the main things a potential investor looks for in an investment?

Answer: A financial investor (an investment fund or an individual, for example) will look for a soundly managed company in an attractive sector with good growth prospects. A good track record and a reasonable market share help. Above all, the quality of management and a clear strategy are vital. Before making a final decision, investors typically seek to verify the information presented to them on a potential investment. This is called a “due diligence” process and involves an examination of the company from a number of angles, including accounting/financial, legal, technical, operational and staffing.

A financial and a legal audit may be required by an investor.

How involved does a fund become in the day-to-day management of a company they invest in?

Answer: Good investment funds do not have the time and resources to become involved in day-to-day management. Funds generally ask for a seat on the Board of Directors from where they can influence the strategic direction of the company.

Could the information provided by a company be misused by the fund in order to purchase a competitor?

Answer: A Confidentiality, or Non-Disclosure, Agreement is typically signed to safeguard secrecy. One can never guarantee unauthorized disclosure, however. Osprey is mindful of this and prefers to work with parties who have a good reputation. Signed agreements are only as strong as the name of the party signing it. If a fund were to misbehave, they would lose the trust of the market.