Private equity – why? Why not?

Over the years the private equity industry has come in for some high level political criticism and even satire by the likes of Terry Pratchett in his book Postal Services but back in the real world of the North East what’s been happening and why?

Martin Hulls

Just this year we have seen the investment by NorthEdge into Ramsdens Financial and the sale of Aesica Pharmaceuticals which, until a few years ago, was supported by Lloyds Development Capital but at the time of the sale this year had Silverfleet Capital as its investor.

Last year saw a raft of private equity investments in the area: Lloyds Development Capital’s investment in Express, the then ISIS Private Equity’s investment in Nigel Frank to add to their earlier investment in Onyx and NorthEdge’s first investment in the region in Fine Industries.

If we look back further, there were a whole raft of successful companies in the region who were supported by 3i – Pride Valley Foods, Dataform and Bede Scientific to name a few.

So why all this interest, what’s in it for private equity firms, what’s in it for the company and their owners?

The answer is of course obvious – money and profit.  But how it all works can be a bit of a mystery if you haven’t been involved before.

What private equity investors are looking for are generally fairly well established businesses that have exciting prospects to grow and develop.

They make their money by normally investing their cash in companies via a mixture of shares and debt.

The debt – like any form of debt – has a rate of interest return on it (quite high as the debt is effectively unsecured) but the exciting element is their return on their investment in shares.

That return obviously crystallises when they sell those shares, either as happened initially at Aesica a few years ago by way of a sale to another private equity fund or as happened this year at the same company by way of a sale to a trade buyer.

So logically, over and above the actual quality of the business and its management, one of the key issues for a private equity investor considering an investment is how easily and to whom that stake could it be sold over the years following the investment.

This exit strategy needs to be carefully considered when thinking about going down the private equity route of funding.

So what about the companies and their shareholders – why do they deal with private equity investors particularly bearing in mind most companies won’t be used to the level of external influence a private equity fund will require to protect its investment?

There are several reasons. For starters, a company’s plans for growth are just not supportable by the company’s own financial resources or borrowings from a bank.

Of particular interest to shareholders in a company is that a private equity investment can often allow those existing shareholders to realise some of their locked-up value in the company at the same time as providing the company with the necessary funds to expand and develop.

So what’s the opportunity for the North East? The ability to tap into significant amounts of capital to aid growth and potentially de-risk shareholders’ personal wealth.

Are there any downsides?  Of course, as we all know you don’t get “owt for nowt” – you will have to give up an element of control in your business, but remember private equity backers don’t want to run your business – they want you to do that – but they will want the right to make sure they are happy with any major decisions.

As a final thought, if you are thinking of exploring private equity or indeed have already started talking to a PE fund, go and talk to others that have already been down that route – their insight could prove invaluable.

* For further information on the issues raised by this article, please contact Martin Hulls.