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Choose the right private equity investor

Text Jan Sasse

Private equity investors have a positive impact on the competitiveness, productivity and innovations of portfolio companies. This is the finding of multiple Finnish and foreign studies. But private equity investors don’t always have a favourable reputation. How can this contradiction be explained?

The market has different types of private equity investors and they vary widely in terms of experience, sector and investment focus, and risk profile. Something to keep in mind when choosing an investor is the most likely target of the market expansion. Does the investor have relevant experience with the sector or strong expertise in the segment the company wants to focus on? What kind of investor is the best fit for the company’s goals, or is this even the best possible alternative in the pursuit for financing? Choosing the right partner is a prerequisite for creating a successful growth story.

If the whole company is being sold, the buyers’ investment profiles are not of crucial significance – except in certain special circumstances. (In an earn out arrangement, for example, part of the sale price is paid later on the basis of the company’s financial performance development.)

Most investors, however, want the existing main owners and key individuals to continue with the company, even if the main owner is replaced. In this case, value creation requires that the different stakeholders agree on the chosen strategy alternatives, risk level and investment time horizon. The investor’s earnings logic is based on the portfolio company being sold after a certain period of time or listed on the stock exchange. There should be a shared view on this, too.

My own experience is that reviewing the investor-drafted value creation plan with all the stakeholders before the final investment is a good way to be sure that the goals are shared. But this isn’t always easy to do – e.g. in an auction situation.

Hidden potential revealed

Private equity investors annually review thousands of companies and analyse their strategic potential. Only a fraction of the analysed companies end up as investment targets. For private equity companies, these analyses lead to a comprehensive understanding of the value creation opportunities in different sectors and geographical areas. Sometimes it’s easier for an outsider to see the hidden potential in things like new pricing and service models.

Private equity investors use a significant amount of external expertise when analysing potential investment targets. This is why discussions with private equity investors are beneficial to portfolio companies even if the discussions don’t directly lead to ownership arrangements.

Understanding a company’s unique expertise and connecting it with key macro trends and changes in customer behaviour are an important part of an investor’s value creation plan. Companies whose business relies on correctly understanding the tacit market signals and on the continuously developed know-how supporting them are the most likely winners in the markets where agility and the ability to adapt to quick changes are required.

It often happens that the trends are understood correctly, but the timing of strategic measures is too early.  In these cases, it’s important that stakeholders have both the patience and the ability to react if the strategic choices prove to be incorrect. A key tool here is the practical monitoring of the value creating measures. Many investors have ready-made models for this. For the company, it’s also good if the investor has the ability to make a follow-on investment if the updated strategies require additional investments.

Board support for growth

Investors develop their portfolio companies primarily through Board work. The Board’s composition is one of the most important factors in value creation. In terms of value creation, diverse, international expertise are needed for the portfolio company’s Board. At the same time, it’s important that the individuals appointed to the Board see the overall strategic vision; otherwise, they talk past one another.

In international recruiting, companies can utilise the networks of private equity investors. It’s unlikely that a small Finnish company can recruit world-class talent as a country manager who just happens to be available right now and charges just a moderate fee for his or her services. There’s no such thing as a sure recruit, but practical references from multiple players reduces the number of expensive mismatched recruits.

Private equity investors should be able to give practical support in realising the portfolio company’s M&A strategy. A private equity investor also has a good understanding of what value components to develop in order for all stakeholders to get the best possible price when exiting the portfolio company.

Ideally, private equity investors can bring a lot of real benefits to all the portfolio company stakeholders. This requires consensus from the existing stakeholders on the reasons for decreasing the holding and on the expertise and profile of the investment partner to be chosen. Sometimes the best alternative is a private equity investor, sometimes an industrial partner. And in some cases, simply bringing the relevant expertise to the Board will lead to the best outcome.

Jan Sasse

The blog writer is Finnish Industry Investment’s Director of Growth Investments.