Working with a private equity firm can provide a very different experience from partnering with a venture capital organization. Understanding precisely how private equity entities operate - especially as they interact with the businesses they invest in - is essential in determining the best option for your high-growth company.
What is a Private Equity Firm?
Private equity firms are organizations that manage funds used to invest in high-growth and startup businesses. They blend available general funds with capital they can control from sources, including pension funds, endowments and insurance funds. By combining these resources, private equity organizations can generate the large amounts of capital needed to purchase a controlling share in high-growth companies.
This final point is a key component of what makes private equity firms stand out. They tend to take a more conservative, risk-averse approach to investing in other companies. As a result, they can be more selective than venture capitalists in choosing businesses to invest in and they typically take on more management oversight and leadership responsibilities than some other investors.
How Do Private Equity Firms Generate Revenue?
In simplest terms, private equity investors generate revenue in large part due to the value a business brings in when it either:
- Goes public.
- Is purchased or goes through a merger.
- Is capitalized through an alternative form.
The earnings from these activities aren't the only way that private equity firms gain profit. They also typically take in management fees from the organizations they invest in, creating consistent income.
Why Would a High-Growth Business Consider Private Equity?
You want to grow your business quickly but are running into operational overhead and scaling challenges that are holding you back. That's the typical reason most founders and CEOs seek funding in general. Additional reasons to specifically look for a private equity partner include:
- If you want to get out of your business relatively soon to pursue another opportunity, retire or take some time away from entrepreneurship.
- If you want to take a step back from having such a heavy leadership stake in your business and want to slip into the background a bit.
- If you're looking for a particularly large amount of funding and aren't concerned about giving up the controlling stake in your business.
What's It Like to Work With a Private Equity Firm?
A private equity firm is more than a general partner. It will take on a strong controlling role in the business as it works to maximize the potential value of its investment. An Inc. magazine report explained that this situation often has a huge impact on the founders and executives of the business. The news source described that a private equity firm will typically want to keep the founder around for a period after the initial purchase to sustain current growth and feel comfortable in your business. The investors may even tie the payout you receive from the deal to the sales performance that occurs after the purchase.
While the private equity firm will typically want you to stick around for a while after investing, Inc. noted that you shouldn't expect to be there for too long. Eventually, the firm will want a more traditional corporate presence in leadership as opposed to an individual with an entrepreneurial spirit. This will result in current leaders being fired or pushed to quit.
These factors make a private equity investment a natural fit if you're building toward retirement or alternative projects but aren't quite ready to let go right away. Other key things to expect from working with a private equity firm, according to Inc., include:
- An increase in debt taken on in the business.
- A cultural move toward conservative, corporate strategies.
- A heavy focus on existing assets as opposed to investment value.
- A move toward paying special distributions to the private equity firm when excess revenue is generated.
Ultimately, working with a private equity firm could limit some of the things you love about your business as you lose control of operations. However, it can also provide an incredibly stable source of funding and empower your business to achieve enterprise scale.
How Do Venture Capitalists Differ From Private Equity?
Where private equity firms effectively take control of their portfolio companies in order to ensure growth, venture capitalists partner with members of their portfolio in order to empower them to expand as quickly as possible. This may seem like a small distinction, but it can make a world of difference depending on what you need for your organization.
If you are highly attached to your culture and the personal ideals you've set for your business, then you could quickly end up feeling disappointed when working with a private equity firm that will inevitably change your desires as they work to stabilize growth and establish corporate consistency. This is vital for private equity firms because they take a selective approach to investing and then generate funds through management fees and eventually sales. But the high costs of management make a conservative approach critical.
Venture capital firms take a different approach. By investing in a wide range of businesses in an industry and helping them to grow as quickly as possible, venture capital firms take on more risk. But by handling a higher volume of investments, they tend to be able to avoid losses. This means venture capital organizations aren't as interested in taking control of your business. At Insight Partners, we want to work closely with you, providing guidance and key resources, but we'll allow you to maintain your personal stamp and culture on the company, giving you more freedom than you'd get from a private equity firm.