Private Equity’s Ability to Improve Cash Flow and Further Business Growth
As the economy remains solid and businesses generally are doing well, most construction contractors have likely thought about ways to continue growing their companies. By investing in a minority stake in a business, strategic equity partners can provide capital for growth or shareholder liquidity and help take the business to the next level.
Traditionally, private equity (PE) firms invest in businesses by taking a majority or “control” equity position resulting in them owning more than 50 percent of a company. However, there is a small, but growing, segment of the industry offering minority or “non-control” partnership options. Increasingly, PE firms are dedicating funds to these types of investments, offering owners or management the ability to retain control of (or a majority ownership position in) their business while benefiting from the committed capital and expertise of an established equity investor.
BENEFITS OF A MINORITY EQUITY PARTNER
Construction contractors may need capital for a variety of reasons, including:
- buying out an employee or family member shareholder;
- acquiring a competitor;
- building or expanding a new facility or product line;
- investing in working capital; or
- strengthening the company’s balance sheet.
While debt and equity could both be suitable options, there are several reasons why equity may be preferred over debt. If a company has no current debt, an equity investment allows it to keep continue operating debt-free. If a company already has debt and doesn’t want more, or needs more capital than what a bank or financial partner can provide, equity can solve for that, too.
Additionally, because equity has no required cash interest or amortization payments, it can give contractors greater financial flexibility by not straining the company’s cash flow as debt can. Finally, it’s possible that a bank will remove a personal guaranty on existing debt or not require one on new debt with institutional equity in the ownership base.
When it comes to structuring minority equity investments, there isn’t a one-size-fits-all approach. The right PE firm will work closely with clients to provide a customized equity solution. Frequently non-control equity is structured as “preferred equity,” which means it is senior to common stock, but junior to any debt. It may have an accruing dividend, which does not require current cash payments. It may also participate in or convert into common stock.
Preferred equity typically has “consent rights” pertaining to board-level decisions such as acquisitions and divestitures and other extraordinary uses of free cash flow, but those rights shouldn’t impact management’s ability to run the business on day to day basis.
PE firms with committed capital from third party investors usually look for a return on an investment within a finite period (typically four to seven years), which is often achieved through a sale of the business or some other financing event to create liquidity for the shareholders, including the PE firm. It’s important to keep this in mind when determining whether to bring on a PE partner. It’s also important to recognize this timeline in early conversations about how the deal is structured to ensure it fits an owner’s long-term objectives.
WHY A PRIVATE EQUITY PARTNER?
Many PE firms have expertise in certain industry sectors and can bring operational, financial and strategic resources to help drive growth. When looking for a capital partner, it’s important to select one with the resources, ideas and expertise that best align with the company’s strategic vision and the potential to be most transformative in helping create long-term value for the business. As a shareholder alongside the business owner, a PE firm should be in lock step with the primary goal of building a bigger, better and stronger business for all stakeholders.
As contractors consider capital alternatives, it’s important to evaluate all options and ask the right questions. Above all, contractors must be honest with themselves about the personal and professional objectives for needing a partner and who can best help achieve those objectives.