The Essential First Question CEOs Must Ask Before Partnering with a PE Firm

Operating Advice

The Essential First Question CEOs Must Ask Before Partnering with a PE Firm

This article originally ran in Smart Business Dealmakers on August 2, 2022.

Private equity dealmaking was busier than ever in 2021, with more than $3.5 trillion in capital deployed throughout the year. Fundraising also increased nearly 20% last year – a record high – which will create additional deal demand in the future.

These dynamics in capital markets present an opportunity for middle-market businesses to partner with a PE firm that can provide access to new capital, operational expertise, and technology enablement.

There are many critical decisions for business owners to consider before taking on capital. Everything from leadership change, deal structure, the addition of new Board members, and more. But before these discussions can take place, CEOs and business owners should start with one critical initial question:

Any CEO or business owner looking to partner with a PE firm must first determine the short- and longterm goals for the business and their personal financial future.

There are several supporting questions that can help company leadership determine its goals. What growth stage is the business in? How much control/ownership am I willing to give up? What is my future role in the business? Is this capital for company growth, personal estate management, or both? If the owner is only looking for growth capital for the business, it’s important to understand what resources the company needs in addition to an infusion of capital to reach its future growth forecast, which could include intellectual capital, strategic guidance, industry connections, or corporate governance.

If the owner is looking to take cash out of the business, alignment of interest with the financial partner is critical. It’s important to the financial partner that the owner maintains enough equity ownership in the business to continue to be aligned and incented for a future sale.

One of the biggest mistakes I’ve seen CEOs and business owners make is to take on capital without first identifying a plan for the partnership. Having a clear vision for how to put the capital to work will lead to a successful partnership and must be a priority.

Continuing the Conversation

Depending on the company’s short- and long-term goals, business owners have choices regarding structure, for instance minority investment versus buyout, equity versus debt and more. Each offers its own advantages.

Mezzanine firms are the most ubiquitous providers of PE capital because they can be flexible in their ability to provide both debt and equity. Mezzanine debt is a tool that can provide companies with capital to fund future growth initiatives, whether it’s an investment in CAPEX, human capital, sales and marketing initiatives, technology, or strategic acquisitions. With mezzanine debt, owners can use the capital to invest in their future without taking on dilutive equity or amortizing senior debt that can hinder cash flow and liquidity. Mezzanine debt provides companies an infusion of capital while preserving business owners’ flexibility to grow their business while maintaining control.

It’s critical to identify the best deal structure for the business. Thinking long-term is crucial, as many business owners will want to maintain as much future flexibility as possible.

Finding the Right Fit

Today PE firms have more dollars to invest than any time in history. Companies, CEOs, and business owners considering a partnership must approach any potential deal with a long-term plan. As a former operator and now a Private Equity investor, I’ve learned firsthand the critical importance of taking your time when selecting a partner. The right partnership will be enriching and profitable.

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