Finance governance

Private equity is a source of investment capital that comes from individuals, institutional funds or equity firms.

These funds are used to acquire publicly listed companies and take them private, or purchase shares of private companies, to attain control of the entity and then pursue operational strategy to make a positive return on that investment.


Private equity investments are often designed to gain significant influence over an organisation’s operations. Therefore, the amount of capital to achieve this can require a large amount of money – from hundreds of thousands to many millions of dollars. Some private equity funds focus on particular business opportunities (such as expansions or turnarounds), while others might specialise in one kind of industry. The investment horizon for private equity deals are often medium-to-long-term, usually four or five years.

Private equity vs venture capital

What is the difference between venture capital and private equity? While similar, these forms of investments are differentiated by the size of the investment and by the size and maturity of the organisation.

Private equity funds typically invest in larger, more established entities. Venture capital funds, on the other hand, manage money from private investors looking for equity stakes in start-ups and small-to-medium enterprises (SMEs). Private equity investments typically require much larger sums of capital, but the investment horizon tends to be shorter than in venture capital deals, which are usually from five to seven years.

Understanding governance of a private-equity-backed board

Private equity has boomed in recent years and its impact on global investment markets has received a lot of attention. Less considered is the way this growing sector is influencing corporate governance.

The boards of privately backed entities tend to show more willingness to take on considered risks to grow the business. These boards are driven to navigate innovation and transformation, more so than those of public listed companies, that spend more time on communicating with shareholders.

However, private equity boards are driven to achieve the goals of the investor within a defined period. Boards of a private-equity-backed entity can have a bigger task in meeting the expectations of the firm or fund. The investment timeframe will also influence the style of the board as it fulfils its duties.

These boards are typically smaller, more nimble and less formal. Investment managers will often bring on a non-executive director with extensive experience in the sector or in governing for growth. The will work more closely with the management team – sometimes appointing a key role, such as the finance manager. They tend to spend more time on value creation, finance governance and overall governance for performance, helping the organisation to grow, than on compliance.

As the sector of private equity has grown, investors’ interest in corporate governance and ESG (environmental, social and governance) criteria in measuring performance has accompanied it. Private equity firms are required to demonstrate that they are responsible and capable corporate managers.

These issues make private equity investment seem attractive to those fronting the money, and sound governance practices helps to maximise the entity’s value at the end of the process. New buyers are more confident of a company’s long-term sustainability and the entity can be more appealing public investors, if an initial public offering (IPO) is the intended exit strategy. Good governance systems and practices must be embedded well before a company is listed for them to stick.

Difficulty in assessing a private equity bid

Boards may face a number of challenges when considering a bid from private equity. This time can be particularly difficult to navigate.

Public companies must advise shareholders of the price an equity source is prepared to pay, and must consider whether that price is fair and reasonable and in the company’s best interest – and whether the board will recommend its acceptance to shareholders. In finding the answer to this last point, a board must ask itself whether a private equity fund can provide the strategic drive that is needed by the company, and do a better job of leading the company in a private environment than the board can in its current environment. Many shareholders may struggle with the risk required to transform an organisation from its legacy business model to a new one.

Private equity bids are often made when there is a funding issue. Access to debt or equity is in some respects what directors should be able to organise for an organisation. Does the bid propose a better deal and a better long-term outcome for the company and for shareholders?

Assessing the suitability of a bid can be complicated as private equity proposals are highly conditional (to allow the funds the flexibility to source the debt) and leave an element of uncertainty in a board’s due diligence. What information should be shared with the bidder, and when?

Another challenge to be examined by boards relates to the timing of their communication with the bidder and with the market. It can be a difficult task to determine when a bid is sufficiently certain to share the information with the market. This information might also affect the price of the bid.

Three factors must be kept in mind when preparing for or considering a bid from a private equity fund.

Price

A board should come to an indicative number that they consider is a fair and reasonable value for the company, that also presents a good outcome for its shareholders.

Strategy

The steps to processing a bid from a private equity fund must be established in preparation, to help a board respond.

Alternative bidder

Keep a counter bidder in mind – perhaps a strategic corporate investor – that would be willing to pay a higher price. Strategic corporate bidders can be a good prospect as they are typically more generous in valuation. As a complimentary business rather than a competitor, it would be able to realise more value for the existing business. They also tend to be less restrictive in their terms.

The benefits of private equity in raising capital

Earlier-stage companies that are looking to grow can greatly benefit from private equity investment. Private ownership and guidance from equity firms can strengthen growing companies and prepare them for the next stage of development. This can provide a period of preparedness, and a smoother transition to an IPO. Listing earlier can carry a lot of risk, without first building a sound appreciation of the relevant financial, governance and compliance requirements. IPOs can absorb a lot of the resources that might be better focussed on building up the business.

For an organisation in distress, being privatised through an equity takeover can provide a great opportunity. A number of ASX-listed companies have through this process received the funds and the change needed to return it to a profitable position, then been returned to the share market. Such ‘turnarounds’ can be more easily achieved in the setting of private ownership.

For more on private equity

Learn more about private equity as a means of raising capital with one of our resources below.

'Capital raising' is one of our Director Tools, a suite of documents that provide a high-level overview of director issues and are designed to prompt boardroom discussions.

Company Directors Course Specialisation – Mergers and Acquisitions

Designed for past participants of the Company Directors Course, this focussed Specialisation course is tailored for experienced and aspiring directors whose organisations are preparing for an acquisition or a merger.

Successfully selling your SME – this one-day course equips business owners and leaders with practical tools to prepare for and maximise value when selling their business.

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