Private Equity (PE) funds are not interested in running the day-to-day operations of the investee company. This is left to the management of the company. The fund’s involvement is typically through a presence in the board of directors of the company. The subscription agreement/articles set out the number of board seats they are entitled to, and the circumstances in which the nominee directors will need to relinquish their position.
Consequently, some companies choose to have an Advisory Board, in addition to the board of directors. Being advisory in nature, it does not come with the rights and responsibilities that are applicable to the board of directors. Thus, the company is able to get the guidance of a wider range of professionals through the Advisory board. The PE fund may choose to participate in the Advisory board as well.
Irrespective of the positions they occupy, the support that investee companies can get from the PE investor are as follows:
Setting the strategic direction of the company – The entrepreneur certainly has a lot of knowledge about the business he is building. However, the people in the PE fund have the benefit of being exposed to a range of businesses, either as investors or as former employees. They may also have access to experts in the field, who can add a different perspective.
Inputs that come from the PE team can sharpen the strategic direction of the company, and in some cases, completely change the direction. For instance, they may suggest a change in the market segment targeted, or the business model used.
Strengthening the capital structure of the company – A non-financial entrepreneur does not appreciate the role of capital structure in building the company. He is only interested in getting the money that he can use in the business. A professional PE investor will sensitise him on the nuances of various instruments through which money can be mobilised, and help in developing a capital structure that takes care of the needs of the business and entrepreneur.
Enhancing the scalability of the business – Many entrepreneurs fall into the trap of doing everything, partly on account of cost considerations. This comes in the way of speed of operations and possibly, the entire scalability of the business. The entrepreneur can become a bottleneck for the business, despite all the skills and expertise he may have. The PE team can play the role of a coach in making the entrepreneur aware of the problem, and help him solve the problem. Often, this takes the form of helping the entrepreneur build a strong management team.
Strengthening the management team – The PE investor has a network of contacts in the industry. This would help them identify professionals who can add value to the investee company. As part of their normal involvement in the company, they like to participate in the recruitment of key positions, such as Chief Executive Officer, Chief Financial Officer and Chief Marketing Officer. This can add to the professionalism in the recruitment. Further, the money from the PE investor can go a long way in helping the company bear the cost of a professional management team.
An entrepreneur working on a shoe-string Budget may not have got into the habit of drawing just as much salary as the family needs. Such entrepreneurs find it difficult to offer market salaries to professionals, even if the business can support it. PE funds encourage the entrepreneur to draw market salaries for self as well as pay competitive salaries to other professionals.
At times, professionals are afraid of joining start-ups. The presence of a PE investor gives them confidence and helps get over such inhibitions.
Professionalising the management – A company does not get professional by just recruiting professionals. Various management processes help the company operate in an organised manner and ensure that the company is stronger than the combination of individual professionals it recruits.
Mobilising more money – Investment by one PE fund makes it easier to mobilise from others. Further, the equity brought in by the PE funds can strengthen the company’s capital structure and help it mobilise more debt. The PE team would have access to a wide range of prospective financiers. They can also help the company negotiate better terms with financiers.
Tapping into the network of PE fund– The network of the PE Fund is handy in various aspects beyond recruitment and money. For instance, the business may require a license which may be stuck with a regulatory authority. Or, the company may be finding it difficult to break into a client who can give a large volume of business. In all these cases, it becomes possible to tap into the network of the PE fund.
The private equity fund provides combined support of monitoring and exit. Their performance in the market entirely depends on the return they get in by exiting their portfolio companies and the success rate of startups that they have invested in.