Attracting Private Equity

Guy Davies is managing partner of WestBridge Capital, a private equity house that invests in established, profitable and fast growing UK SMEs. He explains what he looks for in a company wanting to secure funding.

1. Understand how private equity works.

Private equity investors are looking to make healthy returns. We aim to return three times the money to our investors. So a small business wanting to sell to a private equity firm or attract investment from it needs to have a good growth story – but it needs to be more than a story. The owners and management team need to believe in the story and be confident that they can deliver on it. A private equity firm is going to be a partner – but for a limited time. We'll typically exit an invested company after four to five years. So when you take a private equity investor on board, it's rather like getting married knowing that you're going to divorce in a few years. At its best, a small company and its private equity investor are trusted partners achieving common goals.

2. Build an ambitious management team

To attract a private equity investor, you need a management team that has the ambition to take the business forward. That means recruiting the right management team members in the years and months leading up to selling to a private equity firm. If we were going to support a management buyout – one of the ways we invest - we'd be looking for a company which had a management team that had been running the business with the owner taking a back-seat for a period of time before the transaction. The sort of ambitious managers we like to support have typically worked in larger organisations and been recruited into a smaller company to take the business forward. So they're probably over-qualified for the role they have. They are entrepreneurial by nature. They tend to have deep networks within their chosen market niche and they know what they're good at. More importantly, they know what they're not good at and are keen to build people around them in those areas where they need support. So they tend to be self-aware individuals.

3. Focus on unique market strengths.

A private equity investor will want evidence that the business can grow. That means the company needs some key strengths in its markets. For example, we look for businesses that have a 'sticky customer base'. That might mean companies that have repeat or recurring business from customers. For example, we recently supported one company that has a five-year contract to maintain point of sale machines in a number of major retailers. We are also looking for companies with a strong position in their niche markets and which aren't threatened by competitors. Another of our investee companies has regular business from 17 of the 20 top global IT companies. We also like to see strong customer development – a pipeline of new customers that are in the process of being developed. When a company is generating a regular revenue stream, you can be more confident there will be funds to invest in further development of the business.

4. Show how the money will be spent.

When we are evaluating investments we like to see a clear use for the funding. The due diligence associated with a private equity transaction means that there needs to be a detailed plan setting out how the money will be spent, the impact of the investment and how the business will develop over the years. As with any plan, reality may well be different but the business needs to have a plan to focus on. A company could consider hiring an experienced corporate finance adviser with a strong track record of raising funds. Such an adviser could help the owners and management make sure they have considered all of the potential issues before they approach a private equity investor.

5. Prepare the company for change

When a private equity firm invests in a smaller company, there will inevitably be change – so the management team must be prepared and ready to embrace it. We often invest in companies valued at between £6m and £10m and businesses of that size might need to improve their sales and operational processes in order to enable growth. The plan may initially involve adding more overhead into the business to lay strong growth foundations. Therefore profits may initially go backwards. A small business may also have been run by an owner-manager in an informal way. We look to bring larger company rigour and discipline, such as comprehensive board packs and development of comprehensive key performance indicators. For example we want to ensure that all future investment decisions are based on a clear return on capital justification. The clear objective is to work in partnership with an open, enfranchised and ambitious management team to realise the full potential of the business.

Introducing private equity into a business can have a major impact. Sometimes – especially during the early stages – it can be challenging but once everyone is facing the same direction, the journey can be enjoyable, rewarding and life enhancing.