Private equity has an unsettling reputation. Some critics say these firms are vampires – bleeding healthy companies dry and walking away enriched. But, for many businesses, a well-negotiated capital injection from a private equity investor can restore financial security and accelerate growth.
With publicly listed companies hampered by tough trading conditions, the move to private ownership is becoming an increasingly attractive option for business leaders who must answer to demanding shareholders.
One of the main benefits of private equity according to James Winterton, associate director at the Association of Corporate Treasurers, is that businesses can increase their leverage without risking financial stability. “Investors assume a portion of the risk in exchange for equity,” he explains. “This means they share in the business’s success or failure, whereas a debt financier will expect repayments regardless of performance.”
Moreover, experienced PE investors bring strategic value to businesses seeking to streamline operations or enter new markets, Winterton reasons. “With their extensive network, they can boost the profile of a business too.”
But winning private equity investment is not straightforward. Investors are laser-focused on results and returns. They often have high expectations when it comes to reporting, particularly in areas such as cash forecasting, which companies typically neglect by comparison. Culturally, too, private equity is very different from traditional businesses. Finance leaders are responsible for navigating these challenges and ensuring the company is in a strong position to agree the best possible deal.
Competition for private equity investment grows
Securing investment has become more challenging as competition for PE attention grows, says Jasper van Heesch, director and private equity senior analyst at accounting firm RSM UK.
A decline in private equity exits over the past 18 months has led to bloated portfolios, creating pressure to exit and increasing the number of companies available for sale. Private equity firms typically hold on to businesses for three to five years. But, in the UK, the share of private equity firms holding companies for more than four years has been steadily increasing since 2018, according to findings from investment bank Peel Hunt.
As a result, says van Heesch, businesses are having to compete with other PE-backed companies for new investors.
“It’s never too early for CFOs to start thinking about, and preparing for, their company’s exit strategy
“To draw in investors and maximise the chances of competitive tension among possible buyers,” he explains, “companies must focus on optimising their investment story and addressing any weaknesses that can impact a deal.”
Existing investors are focused on identifying top-performing finance chiefs who can deliver high-quality financial reporting assets and understand the growth drivers of the business inside and out.
“The CFO is probably the most important figure in this whole process,” says Christian Davis, an associate partner at data consultancy Jman Group. “The onus is on them to prove they can play a more hands-on role in the growth of the business, rather than just handling financial accounting and auditing.”
Operational inadequacies are a major red flag
To get ahead of these pressures, finance chiefs must button up their operational practices and demonstrate robust risk-management protocols and regulatory compliance.
So says Jenny Burke, a partner in the corporate team at Forbes Solicitors, which works with businesses to prepare them for private equity investment. Any operational inadequacies, she cautions, are major red flags.
“Private equity investors want to know that an existing leadership team and management structure is capable of achieving financial targets and predicted returns on investment,” she says. “They’ll undertake comprehensive due diligence to determine any operational and management shortfalls.”
These insights will help to create a picture of how much time and capital will be required to make the target company into a fully viable investment.
In Burke’s view, finance leaders are responsible for ensuring the management team is aligned with strategic goals and that plans exist to address any underperformance.
Honesty is the best policy
Although CFOs can do little to combat risky market conditions, they must be transparent and proactive if they are to attract private equity investment, stresses Burke.
“There is no point in trying to sweep anything under the carpet,” she says. “Investor due diligence will pick it up and this will just lead to scepticism and erode any faith an investor has in the business.”
Business-leaders must create a detailed business plan that accounts for many different scenarios and includes contingencies to navigate tough trading conditions and economic uncertainty. It should also present realistic growth potential, responses to competition and points of differentiation for the company.
We’ve seen a number of instances where deals have fallen over because of lack of data-led insight
“Being upfront about challenges and demonstrating strategies for overcoming issues will bode well for securing private equity investment,” notes Burke.
She continues: “They do not like grey areas in financial records or any hard-to-explain events and expenditures.” Errors or discrepancies will invite in-depth questioning and often lead to deals being pulled.
Nothing but squeaky-clean financial statements will do. “Financial viability and the ability to demonstrate a clear growth trajectory are of the utmost importance to PE investors,” says Burke.
Financial data must tell a story
Private equity is undergoing an AI-driven transformation, which means deciding where to allocate capital is less about intuition and more about detailed data-driven analysis.
Five years ago, Davis says, anecdotal evidence would have been acceptable, but “this is absolutely no longer the case.”
Investors are now much more interested in understanding how and why certain financial and operational trends are occurring, he explains. Alongside high-quality financial reporting, CFOs must be able to produce data-backed analyses of business growth and future earnings.
This includes quality-of-earnings insights – also known as the customer cube – encompassing everything about how a company generates its revenue, from customer retention rates to the performance dynamics of a product or service.
“CFOs who can harness data and technology to improve the efficiency and quality of reporting can afford themselves more time to think strategically and commercially about the business model and growth levers,” says Davis.
“We’ve seen a number of instances where deals have fallen over because of a lack of data-led insights,” he adds. “Ultimately, high-quality information will not increase valuation, but it will defend higher valuations.”
Think about the exit strategy
While companies can become fixated on getting the current deal over the line, Tom Dutton, senior investment manager at private equity firm WestBridge, says: “It’s never too early for CFOs to start thinking about, and preparing for, their company’s subsequent exit strategy.”
A detailed value-creation plan showing a clear path to exit will give companies the upper hand when it comes to maximising deal value. This is a key, but often overlooked, part of producing an attractive proposition, Dutton explains.
“Investors want to know exactly what objectives the company is aiming for and in how many years. For instance, if that value-creation strategy is M&A, do you have a list of potential targets and do you have an initial blueprint of what the integration of those companies will look like? The more detailed the plan, the more confidence it will build on the investor side.”
Securing private equity investment is just the beginning. From the starting line to the exit point, finance chiefs are up against the clock to meet tough targets and maximise investor returns. The more prepared they are, the more likely they are to come out on top.
What are private equity’s red flags?
Financial records include holes, errors, discrepancies or grey areas.
An inability to support the company’s equity story with data-led insights that show why the company is growing, not just how.
The leadership team is not aligned with business objectives and lacks the ability to achieve predicted financial targets.
Too much emphasis is placed on getting the deal across the line and not enough on how the company will create value and deliver a strong exit.
Private equity has an unsettling reputation. Some critics say these firms are vampires – bleeding healthy companies dry and walking away enriched. But, for many businesses, a well-negotiated capital injection from a private equity investor can restore financial security and accelerate growth.
With publicly listed companies hampered by tough trading conditions, the move to private ownership is becoming an increasingly attractive option for business leaders who must answer to demanding shareholders.
One of the main benefits of private equity according to James Winterton, associate director at the Association of Corporate Treasurers, is that businesses can increase their leverage without risking financial stability. “Investors assume a portion of the risk in exchange for equity,” he explains. “This means they share in the business's success or failure, whereas a debt financier will expect repayments regardless of performance.”
