Private equity investment enables company sellers to obtain capital from financial investors who are more willing to take risks and often withdraw from the investment or financing after a certain period of time. But what exactly does the term private equity mean and what impact does it have on companies and investors? We take a look at this in the following lines.
Table of contents
Definition: What is private equity?
Private equity is a form of corporate financing in which investors invest capital in unlisted companies. These investments are usually made by specialised funds known as private equity companies. In contrast to other forms of financing such as bank loans or IPOs, investors in private equity investments generally receive company shares or participations. This method of raising capital enables private equity companies to realise their growth plans and often generate higher returns within 5-7 years of the investment.
Long-termism is limited to investments of less than 10 years and often characterises the nature of private equity investments, whereby the main objective is to increase the value of the invested company through various strategies. These strategies can include the optimisation of operational efficiency, the development of new markets, the implementation of strategic acquisitions or even succession planning. Private equity investors not only contribute capital, but also their entrepreneurial experience and networks in order to maximise the company’s growth potential.
The importance of private equity company succession
The Company succession is of crucial importance for the success of a private equity company. Medium-sized companies in particular, which are often family-owned, face the challenge of finding a suitable successor who can successfully continue to run the company. This is where private equity investors offer an attractive option, as they can contribute not only capital but also experience and expertise to the management of the company. However, they are very profit-orientated and therefore often deviate from the long-term strategies of a typical family business, which does not always declare profit as its top priority.
Advantages of private equity investments for medium-sized companies
Private equity can be particularly interesting for medium-sized companies. This is because it offers a number of advantages, primarily with regard to company succession:
- Experienced investors provide support in the search for suitable succession solutions.
- Investors’ expertise and networks help to identify potential successors.
- Support in the selection and introduction of new management.
- Development of a long-term strategy for successful company succession.
Challenges and solutions
Although private equity investments offer numerous advantages, there are also challenges to overcome:
- Complexity of the negotiations: The negotiations between the company and the private equity company can be complex due to the variety of contractual terms, valuation methods and financial structures.
- Agreeing on the right strategy and maintaining the corporate culture: Integrating the strategic goals of the private equity investor with the long-term goals and corporate culture of the company can be a challenge.
- Financial restructuring: The need for financial restructuring to improve the company’s profitability and make it more attractive to investors can be difficult.
- Management changes: Changes to the management team or company management may be necessary in order to fulfil the requirements of investors and manage the company more effectively.
- Capital structure and debt: Reorganising the capital structure and taking on debt can be a challenge for companies, especially those with a conservative financial policy.
- Increase in value: Investors’ expectations for increasing the value of the company can be high, which can put additional pressure on the management team and employees. As a rule, PE investors pursue a different culture of value creation than a family-run company.
There are a number of solutions to meet these challenges:
- Clear communication: To avoid misunderstandings, companies and private equity investors must reach clear and transparent agreements.
- Development of a clear strategy: To take into account the goals and expectations of all those involved and to preserve the corporate culture.
- Analysis of the financial situation: To develop the right capital structure for the company.
- Early planning of exit options: To enable a successful termination of the investment, for example through a reverse participation.
Differences to other forms of investment
Various aspects distinguish private equity investments from other forms of corporate financing. In contrast to bank loans, private equity investors are prepared to take a higher risk and invest in companies that are still in the growth phase or face particular challenges. In this way, companies receive capital when traditional financing options may not be available.
Furthermore, private equity is characterised by conditionally long-term investments and an active (determining) partnership with the company. Private equity investors not only contribute financial capital, but also entrepreneurial expertise and experience. In contrast to passive investors such as shareholders on the stock exchange, private equity investors are often involved in the operational and strategic management of the company and have a personal interest in the company’s success.
Succession planning and preparation for private equity investors
Successful succession planning and preparation is crucial to the success of a private equity investment. It is important that the company has a clear strategic direction and understands the goals and expectations of the investor. A good succession plan should take into account the needs and requirements of the company as well as the long-term vision of the investor.
Increasing attractiveness for investors
A thorough Due Diligence is essential in order to assess the company’s financial and operational situation. The investor must understand the full potential of the company and identify possible risks in order to make informed investment decisions. A careful examination of the company’s structure, balance sheets and management is therefore essential.
Effects of a lack of preparation
A lack of preparation can lead to misjudgements and affect investor confidence. Undetected risks can lead to unexpected problems and financial losses. An inadequate succession plan can jeopardise the long-term competitiveness of the company.
Recommendations for entrepreneurs dealing with succession planning
Ensure clear communication and open collaboration between the company and the investor. Transparent communication about expectations, goals and plans to ensure successful collaboration. Involve experts and advisors at an early stage to ensure a structured and successful succession process.
Free guide for the successful sale of a company with concentrated expert knowledge
Conclusion: Private equity as an opportunity for company succession
Private equity investments offer SMEs an attractive opportunity to ensure successful business succession. By working with experienced investors, companies can benefit from their expertise, resources and networks to maximise their growth potential and ensure long-term success. At the same time, the majority of financial investments are not made for an indefinite period of time, but rather PE investors want to exit the risk after less than 10 years.
A clear strategic focus, thorough due diligence and open communication are crucial to the success of a private equity investment. Companies should carefully examine the opportunities offered by private equity investments and, if necessary, seek professional support to ensure a successful business succession.
