When Private Equity Makes Sense
Most startup or small businesses have little use for private equity. Technically Venture Capital is considered private equity, but for the purposes of this explanation let's assume we're talking about all private equity but venture capital.
If you're a pure startup with an idea, you're likely way too early for private equity. Typically private equity firms are looking for later stage companies that require much larger sums of money, usually at least $5 million, in businesses that already have some sort of assets to leverage.
If you have a business with existing revenues or assets, again usually north of a few million dollars, then private equity becomes an interesting option.
Private equity is valuable to businesses that may have a strong operational profile but don't have the high return growth prospects of a technology startup or some other trendy investment type.
How Private Equity Works
Private equity firms pool their money from Limited Partners (LPs) who tend to be pension funds, insurance companies, high net worth individuals, and endowments. The LPs invest in a private equity fund in order to employ a management group to seek out high yield investments on their behalf.
Unlike Venture Capital firms that make big early stage bets that they hope will have an enormous return when the company explodes with growth, a private equity firm bets a little less on speculative growth and a little more on demonstrated growth or opportunity.
The focus of the group is to purchase a company that they can either IPO, sell, or generate cash returns on. The private equity group is essentially betting on the fact that the asset it worth more in the future than it would be worth presently.
This may mean providing more operating cash, providing the owners with liquidity (buying the business from them) or potentially orchestrating a merger or acquisition that will generate more value.
Working with a Private Equity Fund
There are all sorts of private equity funds, from those that do small deals at or below $5 million invested to those that manage multi-billion dollar deals. In each case they are looking for existing assets that could be better positioned with outside capital.
Working with a private equity fund will require a great deal of preparation and diligence to say the least. At the point in which private equity gets involved the finances of the business will be the central component, so knowing your numbers inside and out will be critical since private equity is less focused on the vision and more focused on the numbers.
By the time you are ready to start talking to a private equity firm, you're likely to be a pretty experienced entrepreneur with a great track record for success. Unlike just about every other type of capital, Private Equity isn't really associated with startup capital; it's associated with growth capital.