Now and then we see start-ups and small and medium companies raise a large amount of money. This capital is utilized by start-ups and companies to grow their business. However, the current scenario isn’t the same as it is today. It’s more common today for start-ups and small companies to have ownership of private equity firms.
As the private equity trend is accelerating, entrepreneurs and business owners need to understand how private equity investors have evolved and the motivation behind investors’ behaviour.
Why does every start-up or small company have a private equity stake?
In 2020, nearly every start-up or small-medium company has stakes owned by private equity firms. However, this wasn’t the case before 1995. Before 1995, the total fund raised by U.S. private equity firms was less than $100 billion. Things changed post-1995. Private equity firms raised more than $50 billion every year. In 2007, firms raised nearly $250 billion for funded buyouts.
All this cash went into funding start-ups and profitable companies, which led to higher valuations for companies. Growth-stage companies benefitted the most. Entrepreneurs who had grown their company to sustainable profitability were able to raise cash easily or profit by selling their companies at attractive valuations.
What drives private equity investors?
The goal of private equity investors is to return. The average return for private equity funds in the early 1990s was somewhere between 30-50%. This much return attracted investors from all places. Major investors came from institutional funds like pension funds, who were seeking higher returns than their usual public market returns, which was way less back in the 1990s.
However, this didn’t continue for a long time. Private equity funds that were flush with cash, paid higher valuation, which gradually began to give lower returns. The average return post-1995 in U.S. buyout was 20%. All in all, private equity investment wasn’t any better than stock investment.
Now private equity investors are more selective in their investments. Thus, entrepreneurs need to be more proactive and better prepared while looking to raise funds.
What entrepreneurs can do about this?
All private equity investors are not the same. So entrepreneurs need to find investors who find their motivations the same as them. Angel investors, venture capitalists, institutional investors, and buyout funds vary in their approach to investments.
While some funds may invest for the long-term, others are interested in short-term returns. As an entrepreneur, if you’re looking for growth capital that will yield return in the long –term, you will likely be at odds with investors who are looking to make returns in 5-6 years. In this scenario, you should look at investors who are looking to invest for the long term.
Finding the right partner is extremely important, if you’re looking to raise fund to grow your business.Cases where entrepreneurs clash with investors, which ultimately head toward a fallout are common. Document your questions to find the right private equity investors for your business. Don’t be tempted to take the money from a firm just because it’s available.
In the post-2000 era, private equity industry has diversified and firms are extremely niche in their investments to get better returns. At the same time, investments have become a necessity to grow companies. Therefore, entrepreneurs should understand the motivations of capital providers before taking cash from them. You should ensure that investor and you have the same goal and are ready to work toward them.