Once the entrepreneur has exhausted his funding sources he needs to turn towards raising equity from private equity players. It is important to select a good private equity partner since this investor will stay with you all through thick and thin till he is able to find an exit.
As a promoter one’s passion is to build a strong brand and a resilient company that will survive over the years. On the other hand a private equity player is in the business of making money and therefore, very rightly their interest is only on how soon they can get their desired return and exit from the company.
The best way to approach private equity players is by appointing a good Investment banking company which specializes in raising money for the industry you are in. the Investment Banking Company will work with you to prepare an Information Memorandum and introduce you to potential investors.
Even if there is a considerable pressure on funds, the promoter needs to ask the private equity player important questions such as how long is the life of the fund, what their exit time horizon is and most importantly what will they bring to the company other than money. It is better to ask such questions before the funding than to find out later after the investment has been made.
Unless one’s private equity partner shares your dream, there will be contrarian positions between the two partners at most board meetings which will prove dysfunctional for the business of the company. It is also important for both partners to agree on the time horizon for the exit of the private equity investor. I have seen a lot of companies being pushed into going for an Initial Public Offering very early in their lives even though the promoter felt that the timing was early.
The discussions with the potential investor will revolve around valuation of the company, the amount of the investment and the percentage of dilution. Terms such as pre-money and post-money valuation must be understood by the promoter.
Once there is agreement on the terms of the investment with the private equity player, it is critical to get this incorporated into a term sheet. For most promoters, it is recommended that they get a good lawyer who can help the promoter to understand the legalese in the hundreds of pages of agreements. The promoter must understand the key provisions in great detail. It is also essential to read the agreements carefully with specific reference to the rights and responsibilities of a promoter.
Watch out very carefully for the IRR percentages that are being built into the Default Clause and Liquidity Preference Clause of the agreement that you will sign. Sometimes innocuous numbers that initially seem to be very reasonable can come back to bite you after a few years when you suddenly realize that a large chunk of your own equity has been diluted because of the IRR guarantee that you have signed in the investment agreement.
Set up monthly review mechanisms with the investor and make sure that you record the minutes of the meetings very carefully. Copies of minutes should be sent to the investor to guard against a future denial of what was discussed in the meetings in the event your business runs into a problem.
As an investor in your company, the private equity investor is as responsible as the promoter to work towards the growth of the company. I have seen several instances of companies which are under performing where the private equity investor has attempted to step in and then made a complete mess of an already challenging situation.
Raise private equity but with caution and with your eyes open.