This article seeks to explain how a private company can tap into private equity (PE) in raising funding for its business. Many times financial advisors are approached by shareholders and executives in private companies in need of business funding.
According to section 85 of the Companies and Other Entities Act (“COBE Act”) a private company means a company, which by its articles:
Restricts the right to transfer its shares,
Limits the number of its members (shareholders) to 50, and
Prohibits any invitation to the public to subscribe for any shares or debentures of the company.
Funding usually sought by companies
Ordinarily companies use funds from existing shareholders or seek borrowings in the form of loan or overdraft facilities in order to fund working capital and capital expenditure. Alternatively, companies may resort to seeking a potential equity investor to come on board which results in them being diluted.
When existing shareholders are looking for potential equity funding they are usually looking for high net worth individuals (“HNWIs”), small to medium companies or at times large corporates. It appears many of them are not aware of the existence of private equity firms and how these can be useful to them, hence the need for financial, business or legal advisors.
Private equity consists of capital that is not listed on a stock exchange. It commonly refers to funds and investors that invest directly in a private company. The general private equity investment umbrella encompasses private equity firms or venture capital firms.
A private equity manager, generally referred to as General Partner, uses funds from the following sources:
Institutional investors (pension funds, insurance companies, corporates)
A private equity firm funds equity investment or acquisition in a target company through:
Direct purchase of equity in the target private company using funds from the above sources or
Through a leveraged buyout (LBO).
A LBO is basically the acquisition of a company using a significant amount of borrowed money to meet the cost of acquisition. The assets of the company being acquired are often used as collateral for the loans at times together with the assets of the acquiring firm.
Private equity firms usually prefer acquiring controlling or significant equity in the target firm to influence management of the acquired firm. Such influence can be achieved through for example voting at the target company general meetings of shareholders, appointing board members, and / or management.
After acquiring controlling or significant stake the acquiring private equity firm usually:
Directs the management of the acquired company,
Restructures the acquired firm to improve efficiencies, liquidity, profitability, and overall value of the acquired company.
Venture capital firms
Whilst a private equity investor targets existing but usually under-performing companies a venture capitalist focusses on start-up companies which have the potential to grow rapidly but are in need of funding.
Benefits of private equity to the acquired company
The company in need of funding benefits from the coming on board of the private equity firm in that:
It receives long term funds, unlike borrowings which can be short term and bear interest,
It receives strategic input from the private equity investor,
The private equity can unlock additional debt funding for the acquired firm from its networks,
The private equity firm can provide the acquired firm access to new customers, suppliers, relationships, and
The private equity firm may eventually exit the acquired company, with the original shareholders having the right of first refusal to buy the shares or the company buying back its shares.
Benefits to the acquiring private equity firm
There are always questions as to the benefits of the private equity firm in this arrangement. The private equity firm benefit through:
Dividends when the acquired company posts profits and dividends are paid, and
Upon selling part or all its stake in the investee or acquired company and realising a capital gain on the shares sold.
Examples of private equity firms
Some well-known global private equity firms include Blackstone Group Inc, Vista Equity Partners, CVC Capital Partners, Apax Partners. In Zimbabwe one might be familiar with for example Takura Capital Partners, Vakayi Capital, etc.
Transactions involving raising of business funding can be complex. Entrepreneurs and executives are advised to engage financial, business or legal advisors for professional assistance in such initiatives. This article, which is based on various sources, is simplified, for general information only and does not constitute full professional advice.
Godknows Hofisi, LLB(UNISA), B.Acc(UZ), CA(Z), MBA(EBS,UK) is a legal practitioner, chartered accountant, corporate rescue practitioner, and consultant in deal structuring and tax. He writes in his personal capacity. He can be contacted on +263 772 246 900 or [email protected]