Giving Up a Small Piece of Your Company Can Bring Big Payoff
Are you having trouble borrowing from your bank or commercial finance company? Do you fear that without credit you can’t expand your business in a slowing economy?
Don’t despair. If you run a healthy company with good prospects for growth, you have an alternative that can strengthen your business and propel it safely through the economic slowdown.
How? Find an equity partner to inject growth capital into your company in exchange for a piece of the action. It might be a healthy piece of the action, given the risks of a slowing economy, but maybe not big enough to make the strategy a bad idea.
“Equity investor funds are in an interesting position,” said Jonathan L. Schwartz, president of the Beverly Hills investment banking firm JLS Capital Inc. “They’re under pressure to find opportunities because they have a mandate from their investors: Use the money or lose it.”
This means there is plenty of equity money looking for opportunity among mid-size businesses with healthy growth prospects. If you run such a business, it may pay you big dividends to explore the idea.
For many business owners, the argument against equity investors is that they cost you equity, as distinct from lenders, who cost you only interest. But in tough times equity investors can prove to be valuable allies in expanding your company because they have capital to put to work in the right places.
What kinds of deals are equity investors doing these days?
“Companies are going to get financed if they have good cash flow and solid management and a history of operating earnings in bread-and-butter industries not affected by recessionary pressures,” Schwartz said. “But the deals will be structured with less debt and more equity.”
He said equity investors want a bigger piece of the action than they did a year ago, in large part because institutional lenders--including insurers, pensions, endowments and banks--have turned skittish about backing equity deals with a heavy layer of debt.
Other things being equal, less debt means less leverage for equity investors. Hence they can’t make the money they want--often an internal rate of return averaging 30% to 40% over five years--unless they buy a bigger chunk of your business.
The result: You can still find outside capital but it comes at a price--the dilution of your own equity position in your company.
Investor funds not investing in technology companies are flush with cash,” Schwartz said. “But it’s harder to get deals done if you want to bring in lots of debt. Lenders aren’t closing their doors, and equity funds aren’t, either. . . . But the quality of the business has to go up. Good companies will get financed. Lower-quality companies will have a tough time.”
If you gather from all of this that it takes some work to put together an equity deal in this climate, you’re right. Your business must look good to an investor group, showing high cash flow, solid margins, a low debt-to-equity ratio and good growth prospects in an “old-economy” sector.
You must also follow the rules in making contact with investor groups--meaning don’t try to go it alone. Networking was the key in the heyday of the dot-com revolution, and it’s even more necessary now.
“Doing a deal is highly dependent on the quality of your introduction to your equity investor group,” Schwartz said. “There are tremendous opportunities out there in the middle market--privately owned companies with revenue of $10 million to $200 million--and there are a thousand different equity groups. But the presentation can’t come out of thin air; it has to come from a professional who has a relationship with the group.
“The drill isn’t much different than it was a year or two ago, because how you go out to raise capital is always the same process. But what will get financing is different, and so is the capital structure of the deal you make.”
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Recent Finacing and Insurance columns are available at https://www.latimes.com/finin. Juan Hovey can be reached at (805) 492-7909 or at jhovey@gte.net.
