A VC Leaps to Private Equity’s Defense
Recent attacks against leading GOP presidential nominee Mitt Romney depict him essentially as a brutal, bare-knuckled capitalist when he ran Bain Capital. They shed a very unflattering light on the private equity world. Romney rivals have cast him as a “vulture capitalist” that took over companies, aggressively sold significant assets and fired workers to maximize profits.
This is highly exaggerated hyperbole. The fact is, private equity firms make significant investments in companies to help super-charge or resuscitate their growth. Sometimes these companies are underperforming industry peers and could be in trouble, but most often they just need private capital to fuel a well-structured expansion strategy. And private equity firms don’t make a profit unless they significantly improve the company’s state of affairs.
Private equity is different from venture capital. It can be effectively used to bolster the growth of a venture capital-backed company. In fact, at Claremont Creek Ventures we often use private equity to help fund momentum in our portfolio companies. A good current case in point is SST, Inc, formerly known as ShotSpotter, a Claremont Creek-backed company that is the world leader in gunshot detection and location technology –their ShotSpotter system. SST, Inc. is now seeking growth capital –essentially private equity– to grow its business by aggressively expanding into Brazil and elsewhere in Latin America and acquiring a synergistic data analytics company.
SST Inc. is primed for growth fueled by private equity. It has deployed a total of $50 million in venture capital and owns virtually its entire market. More than 65 law enforcement agencies in the United States and elsewhere have deployed its technology. In short, most risk has been flushed out of its business model, and now it’s time to turn to private equity financiers, who are great at further developing expanding businesses, rather than venture capitalists, to help grow further. In the case of SST Inc., a private equity investor needs to be mindful only of the company’s execution, not its strategy.
We’re not viewing private equity as the “enemy,” and we don’t expect SST employees to, either.
Sequential relationships with venture capitalists and private equity investors at the same company often make good sense. The evolution naturally starts with venture capital, which is financial capital provided to early-stage, high-potential, high risk growth startup companies. A venture capital round, which occurs after a seed financing round, is all about feeding a company until it reaches early adulthood. Venture capital clearly makes sense for new companies that have not reached the point where they are able to secure a bank loan or complete a debt offering. In exchange for the high risk that venture capitalists assume by investing in startups, venture capitalists usually have substantial input in company decisions, in addition to a significant portion of company ownership.
Once a company has established a solid growth trajectory, as SST has, private equity or other sources of growth capital can become more attractive. At this point, many of the company-building strengths of venture capitalists may become less important. Companies like SST Inc. seek private equity to finance a transformational event in their life cycle. They are likely to be more mature than venture capital-funded companies, able to generate revenue and profits but unable to generate sufficient cash to fund major expansions or acquisitions.
SST intends to soon raise $15 million to $25 million in private equity to accelerate growth. The company has successfully augmented sales of its systems, which sell for $250,000 per square mile, with a successful managed services offering that costs as little as $40,000 per square mile per year. There is little downside for SST in seeking private equity at this point. As we have seen at Claremont Creek Ventures, private equity is usually good for the economy and companies, not bad. Most importantly, SST is learning that private equity can play as important a role in the evolutionary growth of a company as venture capital – an excellent lesson for other young companies to embrace.
Randy Hawks is a co-founder and managing director of Claremont Creek Ventures, a seed and early stage investor in technology and digital healthcare.
MM said on February 16, 2012
Leveraged buyouts became part of traditional capitalism in the 1980s, when financiers started borrowing piles of money, often at high interest rates, to buy up the shares of companies they believed to be “undervalued” — Wall Street-speak for companies that can be squeezed for more short-term profits. The financiers back the loans with the companies’ assets, then typically sell off divisions and slim payrolls, and resell the companies to the public at a higher share price — pocketing the gains. This can be detrimental to nationalism because these are international companies with extensive off-shore tax havens.
Randy Hawks said on February 16, 2012
Private Equity takes many forms. Growth capital funding is typically not leveraged but direct investor equity. In any case, it’s a useful tool for the continued expansion of a company’s business strategy and operations. Leverage, when used, can be helpful or dangerous. Sort of like using the bank’s mortgage money in buying a home. Prudent decisions required!