When looking for minority investors, company owners and their chief financial officers often fear investors will shake up the management structure and harm long-term client, employee or supplier relationships. Owners considering outside investors often wonder, “Will our business wind up in a chop-shop, or will our legacy live on?”
The answer comes down to control. Minority investors will typically take 15% to 49% of an enterprise. Today, smaller transactions are on the upswing because of a surplus of investment capital, scarcity of larger opportunities and investor desire to broaden their portfolios.
In the first half of this year, minority private-equity investment accounted for more than 30% of all private equity deals, according to PitchBook Middle Market Report, an industry newsletter. That’s a 25% increase over each of the two prior years.
Minority investors can enable business owners to partially cash out and gain financial diversification. For companies, they can infuse some critical financial and intellectual capital.
But companies looking for a minority investor should consider:
The relationship between a company and its minority investor is often like a marriage. Unlike a buyout where company owners cash out and leave, a minority investor will be locked arm-in-arm with the current ownership as the company moves forward. This relationship requires special consideration:
Time for “Dating”: When a company considers being bought out, the main objective is to maximize price. However, with a minority partner, both parties are “investing” in a long-term relationship. Before approaching minority investors, consider the optimal profile and ideal partner characteristics. Are you looking for investors familiar with your industry? Do you want investors with a hands-on or hands-off approach?
Ask Direct Questions: Too often transactions sour because straight-forward questions were not asked upfront. Questions like:
- What is your vision and investment strategy? How does our company fit into it?
- Who are your primary investors? What motivates their investment decisions?
- What are your other investments right now? Where in your priority list would our company stand?
- If we need more capital down the road, could more be made available for an unexpected opportunity?
- Do they foresee any changes to our management team and will they insist on them?
Call References: Bringing on an investor-partner is like hiring an employee. Ask their references specific questions like:
- Were there ever any difficult situations in working together? What is their personal demeanor? Did they rush to judgment or run over to help?
- If you had trip covenants, how hard did the investor come to enforce them?
- Were they heavy handed in pushing for management changes?
- What business expertise do they have that will be “value added” to the transaction? How do they help with generating new business or finding key executives?
- How did the investor create value that benefited all shareholders?
Preventing Future Problems
While the details of a transaction will vary, here are some general guidelines:
Matching Timelines: Investment capital is a kind of loan. Investors typically want their money back within 5 to 7 years with an internal rate of return above 15% a year. Take a careful and self-effacing look at your business plan and profit projections. Are you being overly optimistic to get their money? If it’s going to take longer to get the investor’s money back, can you legitimately show they will get an even better return if they wait?
Living with Covenants: The agreement will include triggers for the investor to take more control if the company does not meet defined expectations. Take the time to talk through possible scenarios and how those can be arbitrated rather that dictated.
Keeping the Minority Investor Informed: Part of the beauty of a minority investor is that there is less day-to-day activity with operations. Try to decide in advance what corporate decisions should be run past the investors as a matter of courtesy versus a requirement.
Personnel Changes: If, during the evaluation process, it becomes clear that certain personnel changes are needed, address the issue upfront and determine how much time should pass before there are major shifts in management.
In the current market, investors have a lot of capital and many are seeking minority opportunities. But at the end of the day, the question is not about the money, but how strategically the investor and management team work together to build the business.
Paul Schaye is a managing director of Chestnut Hill Partners, a New York-based boutique investment bank specializing in mergers and acquisitions.