Whilst private equity has gained remarkable traction over the last few years and is a sought-after way of acquiring capital by companies looking to grow, it doesn’t come without its own unique challenges.
According to Australian investor, Darren Herft, private equity is a great option to source financing for an already established business or start-up, but there are some disadvantages that companies must be cognizant of.
He says, “Liquidating holdings in private equity can prove to be an uphill task as, unlike the public arena, there is no system in place that matches buyers and sellers.”
Private equity firms must search for buyers to make a sale of their company or investments. This task has an added layer of complexity as share pricing in the private equity sphere is not determined by market forces but via agreements between buyers and sellers.
“Prolonged negotiations can cause massive losses for a firm,” says Darren Herft.
Unlike public companies, negotiation also forms the basis on which the claims of various private equity shareholders are decided.
For companies looking for investment, acquiring financing via private equity can be a burdensome process. Investors require companies to put forward a compelling case to warrant their involvement.
“Any company seeking funds this way needs to possess positive metrics vis-à-vis their growth projections, turnover history as well as competent past performance to qualify,” says Darren Herft.
He thinks that start-ups with novel ideas that seek to make a dent in the market and need financing through private equity need to be thorough with their research before making such a bid.
“Finding a gap in the marketplace isn’t an indicator of profitability and profits are what private equity firms are looking for,” adds Darren Herft.
Darren Herft cautions businesses attracted to private equity due to its lack of regular payments. As the lack of loan status comes at the cost of shares in a business. This translates into stakeholders having the ability to make major decisions regarding the acquired company.
“It is important for a business to carefully consider how much equity it’s willing to dispense within such a manner,” says Herft.
A robust reporting system, created to keep investors up to date regarding company performance is crucial in Herft’s eyes as it regularly reassures shareholders and helps reaffirm their faith in a company’s success.
Herft thinks that there is no room for carelessness when tied to private equity as investors could easily appoint new management and even revamp the entire organizational structure of a business acquisition.
“There is also the likelihood that investors might sell their equity to an entity with opposing views from a company or even a lack of expertise, but still have a key say in all decisions if the transaction is not negotiated effectively,” he says.
Current leaders of a company planning on buying out their shares from their private equity firm once growth margins have been reached must bear in mind that the value of their shares increases with the growth of their business.
He advises founders and business leaders with such aspirations to have a realistic plan in place.
“Clarity is key,” adds Herft.
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