Late-stage business owners often talk to our team about Venture Capital (VC) firms having interest in acquiring their companies. At the same time, start-up businesses talk to us about seeking investments from Private Equity (PE) firms.
If you’re a business owner and you’re looking to raise capital and/or sell your company – who should you be talking to? It’s important to understand the key distinctions between the two types of firms in order to save yourself time and to maximize the value of your relationships. Here’s what you need to know:
Investment Thesis
PE firms focus on mature companies … typically five-plus years in business with proven cash flow. While these companies are typically firmly established, they may be deteriorating or not making the profits they should be. PE firms provide working capital that is often used to fund new product or service line development or enable organic expansion. To the same extent, they will likely be seeking add-on acquisitions of other complimentary businesses in their space.
VC firms mainly invest in smaller start-up operations that have a high-growth potential. As a result, VC firms are typically industry-focused and function in the technology, biotech, healthcare, and cleantech industries. In general, VC firms tend to invest in riskier businesses than a traditional bank or PE fund is willing to take on. This type of thesis is more apt to generate home runs or strike-outs versus the PE model, which is somewhere in the middle.
Investment Risk and Percentage
PE firms invest in already established companies, often buying a 100 percent ownership stake. Since they take total control, their risk of absolute loss is minimal.
VC firms focus on early-stage and start-up companies. On the opposite side of the spectrum from PE firms, VC firms typically make smaller investments across many start-ups, diversifying their risk. Start-ups do not have the track record of success that established companies have and these are riskier investments. It’s likely that most of the companies in the portfolio may fail, but if one company becomes “the next big thing,” they could still earn significant returns, thus making the risk favorable. PE firms can’t afford that level of risk – one failed company could doom an entire fund.
Value Creation
Both firm types aim to earn returns above those of public markets yet do so differently. VC firms rely on the growth from their investment and companies for their own valuations to increase. Without some financial growth from their start-up investments, VC firms won’t yield any returns.
PE firms have the upper hand in creating more value through “financial engineering,” involving multiple expansions, debt pay-down, and cash generation. Again, because these companies have turned a profit already in the past, it is expected that they should be able to increase their earnings into the future, under the tutelage of an experienced PE firm.
Our team specializes in working closely with middle market PE firms. If you are looking understand how you or your firm fit into the private capital matrix, contact us today.
Over the past several years, private equity firms have been increasingly interested in investing in add-on acquisitions, rather than platform companies. While the current economy has solid footing, more businesses are returning to the mergers and acquisitions marketplace. This opens the door for acquiring new platforms and broader possibilities for supporting add-ons.
What are Platform Companies?
Platform investments are companies that a private equity group (PEG) can view as a starting point for more acquisitions, or add-ons, to follow in the future. Normally, new platforms include companies in high-growth industries that are commanding a significant market share. Platforms are generally of sufficient size and have the capability to acquire and support add-ons. Often, these platforms are reasonably capitalized and have broad market exposure, although are usually limited to one industry. When sold, platform investment companies are sold at premium price.
What are Add-ons?
On the other hand, add-on companies are not normally viewed as industry leaders. These companies are more prone to suffer issues with management, undercapitalization, and lack of exposure in their industry. Add-ons are marketed by boutique investments banks or small companies to be sold to larger platforms. Estimates can vary, but add-ons constitute about 40-50% of private equity buyout activity. Generally, add-ons provide complimentary services, technology, or expansion to larger platforms. Depending on the industry, add-on companies may be considered competitors to the original platform company, yet they are added with the goal of increasing overall revenues and earnings.
“Buy and Build” Strategy
While both new platforms and add-ons serve separate purposes, using them together can create maximum profits. The “buy and build” strategy is normally employed by private equity groups to increase their returns and generate value. This strategy entails buying a new platform company, with its already established management systems, and leveraging it to acquire subsequent add-on acquisitions. To successfully transition through this strategy, private equity firms must have significant experience in platform management, as this process requires serious change. The “buy and build” strategy is most commonly deployed in a slower economy as a way to improve returns. These strategies can become challenging as it takes time to properly acquire and integrate several companies together.
At Symmetrical Investments, our main focus is to maximize value. If you have questions or are interested in these types of investment, contact us to learn more.