When considering liquidity options for their business, many Canadian entrepreneurs seek out deal structures that allow them to sell most of their ownership to a private equity firm or other financial investor while remaining in a management capacity and retaining a stake to get a proverbial “second bite at the apple.”
Having been exposed to many such deals – as buyer and seller – my experience has shaped Carpedia Capital’s perspective on the key considerations for entrepreneurs to ensure they select the right partner and avoid shortcomings of the capital-raising process.
Selecting a financial partner is an opportunity fraught with risks. Typically, a capital-raising process introduces the entrepreneur to a number of PE or other investors in the course of a few weeks, in the investment banking equivalent of “speed dating.” From these heavily-orchestrated meetings and the resulting indications of price and other deal parameters, entrepreneurs are expected to select the preferred partner with which to “go exclusive.”
The importance of this early decision point is not to be underestimated, as it starts a time-consuming and expensive diligence process prior to attempting to consummate a transaction – and it’s very difficult to change the selection at a later point without badly impacting the entrepreneur’s negotiating position or waiting an extended period of time to restart the process.
I have observed that this selection process tends to over-emphasize raw cash price and the likelihood of an expedient closing, rather than a more balanced assessment of total value and alignment to the needs of the entrepreneur. This usually happens for three reasons:
Limited awareness by the entrepreneur about investors. While information will have been given to the investors about the business and entrepreneur, there typically has been much less reverse dialog in regards to the potential partner and its people – making it hard for the entrepreneur to make a decision other than by intuition based upon limited interactions and the perspective of key influencers. In comparison, we have seen entrepreneurs invest more personal time and effort into selecting key employees than into the selection of an investor.
Motivations of key influencers around the entrepreneur, such as the financial advisor, lawyer or accountant. They tend to be price-focused because of the commission or success metrics that determine how they are primarily paid, and have personality types to match. They are the primary interface with potential investors and typically prepare and lead the discussion of the entrepreneur’s options; that gives them substantial weight in the entrepreneur’s decision process. If the key influencer works as part of a larger institution, they may also have secondary aims related to their employer’s other product lines and relationships which can influence their actions and recommendations.
Structure of the process itself, often with a linear schedule geared around milestones and time-frames designed to move the selection and diligence process forward and manage the large number of people involved in the working groups.
While these factors help drive the momentum required to get a deal closed, the pressures they create make it easy for the entrepreneur to lose sight of the fact that they are going to have to spend the next five to ten years in a potentially hastily-made partnership, selected primarily on the basis of price rather than other, equally important criteria. Only after the deal is done and the euphoria fades does the realization set in that the finish line is really only the starting point from which the entrepreneur must then develop a meaningful partnership with the often relatively unknown, and now in control, investor.
Key financial partner selection criteria. For those entrepreneurs looking to get their “second bite at the apple,” and provided a reasonable and market-based price is offered, the following are important upfront considerations in selecting the right PE or other financial partner for a constructive long-term relationship:
Value-add: It’s vital to pick a private equity firm or other investor who offers the most chance of enabling the entrepreneur’s and the employees’ future success, with the highest degree of certainty. This is the most important consideration because the potential to recover the rolled-over stake and the new “value creation” is dependent upon future results. Therefore, the best financial partners contribute strongly to development and implementation of strategy, fostering the development of high-quality people and the optimization of processes, systems and behaviours.
Good character: The qualities entrepreneurs must look for in their financial partners include integrity, open-mindedness, humility, self-motivation and hard work. Partners also need to be results-oriented, transparent and equitable – qualities which are essential to maintaining balance in the relationship. Actions always speak louder than words, and the true picture of character often emerges through anecdotes about past deals and experiences that demonstrate integrity and consistency of approach – particularly in the face of adversity. Independent references are also a key test, but should be used to confirm, rather than form, the entrepreneur’s view of a partner’s character.
Personal fit and consistency of personnel: Personal chemistry is critical, as entrepreneurs will be spending large amounts of time with their new financial partners. From shared interests to a sense of humour, there must be more to the relationship than just the business. Also critical is whether the decision-makers involved in forging the deal with the entrepreneur will be the same as those overseeing the investment throughout its life-cycle – uncertainty in this regard is a significant issue.
Strategic alignment: There are many ways to grow a business. Alignment enables the entrepreneur and his team to confidently deploy resources and execute plans to implement the agreed strategy. In contrast, a material misalignment in strategic intent will delay progress and waste time and resources while the business’ direction is debated. Furthermore, a misalignment can even fracture the sought-after partnership as the investor exerts their control over the company. Having a shared understanding of where, as partners, you collectively want to take the business and how you are going to do it over the next three to five years is an essential pre-condition to selecting the right financial partner.
Financial alignment: Entrepreneurs should require the same degree of alignment with the financial partner’s decision-makers as the latter require of the entrepreneur – the surest sign of which is a substantial cash investment from their personal accounts that puts meaningful dollars at risk on the same terms as the entrepreneur.
Naturally, it is hard for entrepreneurs to avoid being swept up in the whirlwind of making a deal and to maintain focus on long-term criteria such as value-add, character, fit and alignment, when those around them may be focused on short-term factors such as cash price and speed to closing. However, such a focus is essential to choosing a PE firm or other investor for a relationship meant to encompass much of the entrepreneur’s remaining professional career and have the best chance to realize the “second bite at the apple” the entrepreneur set out to achieve.
Remember – great private equity and other financial partners are hard to find; focusing on the right selection factors throughout the process is the key to choosing the right one.
Glen Ampleford is the vice president of Carpedia Capital, a Toronto-based lower mid-market private equity firm that invests of behalf of the shareholders of Carpedia International and high-net-wealth investors. If you have comments or questions about this article, please contact firstname.lastname@example.org.
Photo courtesy of Shutterstock.