Private equity can also be a convenient way for SMEs to strengthen their equity and finance their further growth. But how do you attract private equity investors? And how do they operate?
Private equity can refer to many things. Which investment techniques are involved in private equity and in which cases are they used?
Private equity is an instrument used by FPE to acquire an equity interest in a company, either alone or together with other investors. This does not involve a passive investment, but active share ownership: the aim is to engage in a partnership in the medium or long term. In concrete terms, this means that FPE is represented on the Board of Directors as a minority shareholder and in that capacity provides strategic and financial guidance and/or further professionalization of the company.
After a few years, FPE will withdraw from the company again. How this happens exactly is decided in consultation with the co-shareholder(s). They can buy the interest from FPE, but FPE may also sell it to another private equity investor or industrial player.
A company may decide to attract capital for various reasons. A common reason is that the company seeks to finance growth by increasing its activities, internationalising or acquiring other companies. The advantage is that no new private funds or excessive leverage are necessary. Other options are a business transfer or a (partial) buyout of family or less active shareholders.
Venture capital, also referred to as start-up capital, is a form of private equity used to finance early-stage, high-tech companies. These are mainly innovative start-up companies with promising growth prospects. FPE mainly provides venture capital through investments in university venture capital funds.
Mezzanine financing is a long-term subordinated loan for which the company is not required to provide any interim repayments, but makes one lump-sum repayment at the end ('bullet'). These factors mean that the risks of mezzanine financing are higher, which makes it more expensive than a conventional loan with a shorter term, a repayment schedule and securities.
The company does have to generate sufficient returns and liquidity in order to bear the interest charges. The total payment usually consists of a combination of the following elements:
- Cash interest: Interest that is paid at regular intervals during the term.
- 'Payment in kind' (PIK) interest: Capitalised interest that is not paid in cash during the term, but is added to the payable capital and repaid along with the principal.
- Warrant: An instrument that entitles the provider of mezzanine financing to acquire a small percentage of the share capital later. This allows the provider to enjoy a variable payment too.
The exact relationship between these elements depends on the type of company, its future plans and the arrangements it has made with the financier. A company generating a lot of liquidity will be able to cope with a higher cash interest, while a company with a great need for working capital will tend to go for a higher PIK interest or more warrants.
Mezzanine financing is often used for companies facing a financing gap: an investment need that cannot be fully covered with capital or conventional leverage. A company can also opt for this form of financing if does not need external capital injection because there is sufficient equity present or because the company prefers not to open up the capital to new shareholders, for example.
Private equity: not only for growth companies
How does a transaction come about? And which companies are eligible? An interview with Luc Weverbergh and Raf Moons from BNP Paribas Fortis Private Equity.
How is the private equity market evolving?
Raf Moons (RM), Investment Director: "It is currently bouncing back again after the fall that started in 2008. The number of investment requests did remain fairly constant during the economic crisis, but these were mainly companies in difficulties that considered private equity as a last resort. Now that the economy is picking up again, we have noticed that the quality of the submitted files is improving considerably. We expect that more of the younger generation will soon be taking over the family businesses, which will probably push up the number of private equity transactions further."
Luc Weverbergh (LW), Head of BNP Paribas Fortis Private Equity: "There is also more capital available, as evidenced by the increasing number of new – often small or family – investors entering the market. We are also seeing more investments in files that until recently would not have met the return requirements. And still their potential return is substantially higher than the current return of conventional investments. You could consider private equity as an alternative form of investment."
Also as an alternative form of financing?
LW: “I would rather call it supplementary financing, because we help to achieve plans that cannot be financed with bank credits alone. A lot depends on the project the company has in mind. You cannot pay for a buyout with debt alone; you need to put in your own contribution. Take a company that wants to finance its growth, for example. It can do this partly through credits, but the company's financial strength has its limits. In both cases, private equity can offer a solution."
RM: "It is certainly a useful part of the financing mix. Equity is capital and therefore does not have to be repaid. This allows companies to take a little more risk, grow faster and start up bigger projects than with bank credit financing, which impose stricter financial limits because of the interest payments and repayment schedule."
So is private equity suitable for growth companies only?
RM: “Not necessarily, it can also be interesting for mature companies from just about any sector. We mainly focus on medium-sized or large companies with a sound market position, good financials, committed management and a well-considered project. A takeover, a management buyout of tapping into a new market are deal entry points for us.”
And innovative projects?
RM: "Since 1997, we have offered venture capital through investments in university venture capital funds. These funds participate in university spin-offs, but increasingly in 'spin-ins' as well: projects or companies wishing to set up collaboration with universities, in terms of their research, for example. Some examples of such funds are Gemma Frisius (KU Leuven), Qbic (UGent, UA and VUB), Vives (UCL) and Theodorus (ULB). It allows us to give starting entrepreneurs a helping hand and to contribute to the valorisation of Belgian high technology."
How do you get in touch with potential candidates?
LW: "This primarily occurs through intermediaries, such as corporate finance houses. We obviously also look for potential candidates ourselves, by screening business information, through informal contacts, tips from relationship managers or based on articles in the press, for example. A third possibility is that the company itself approaches us. In total, we receive about 100 files every year. These result in investment in two companies through a mezzanine loan or minority stake."
RM: “It does not seem much, but remember that these are €20 million investments or, sometimes even more. We want to enter into a long-term partnership with the company with the intention of creating a win-win situation. This does not happen overnight. It is a growth process that can take months. We have to assess the value of the project as accurately as possible and gain confidence in the sector, the company and the management. The manager of the company needs time to prepare mentally for the entry of a new, active shareholder. Such a perfect fit only happens in a limited number of cases."
What happens during the preparatory process?
RM: “Everything starts with an analysis of the company profile, its past profits and – as we always get our return from the future – the business plan for the following years. We conduct due diligence of the company's financial, legal and strategic information, often together with our external partners. That allows us to assess the project's risks, chances of success and feasibility better. How long this stage lasts depends on how well the company has prepared its file and the point when we are involved in the transaction. If the company uses an intermediary, the financial analysis and due diligence will have been partly completed and things may go a bit faster."
LW: "Another factor is the company's corporate housekeeping. How tight is its structure and organisation? How easily can it provide the necessary figures and answer our questions? That is not always straightforward, as the company manager is often forced to lead a kind of double life during the negotiations. On the one hand, it is business as usual and he needs to keep his business going, but on the other hand, he also has to prepare a major deal. In the early stages, he should handle this deal discretely – not sharing it with anyone or only with a few trusted associates – in order avoid any unrest among the employees."
RM: "The impact of the economic situation is also a factor. A poor economic climate results in smaller growth margins, so private equity providers will investigate and scrutinise the business plans even more thoroughly than in the past. As a result, concluding the deal may take a little more time."
What role do you play as a shareholder?
RM: "During the preparatory stage, we analyse the company's project and the company manager may adjust it somewhat. After our entry, the objective is to achieve this project together with the other shareholders. It is absolutely not our intention to take over the lead from the existing management. We mean to act as a sounding board within the Board of Directors. We can help set the strategic course or further professionalise the company where necessary. In case of a sudden crisis situation or a complex financial problem, our involvement may be a little more prominent."
LW: "We also play a part in the company's organisation and financial reporting. If we see any room for improvement there, we will certainly make some suggestions. We may adjust the operation of the Board of Directors, for example, or we may introduce reporting with new performance indicators. This extra professionalism can help the company assess its risks more thoroughly and take its decisions faster."
RM: "Partnership is indeed key. In order to create added value, we have to combine our specific expertise and experience with the expertise and experience of the management and the other board members. This can only be done in an atmosphere of openness, respect and trust, even though critical questions may be asked and certain traditions may also be questioned. We can usually tell very early in the exploratory stage whether we click with the shareholders and managers. If this is not the case, that may be reason enough for us not to enter that company."
How long will you continue your interest?
RM: "In case of a stake, we want to create long-term shareholder value. That is why our investment tends to last for a five to seven-year term, sometimes longer. In principle, we only withdraw when it is favourable to the company and to us. We do this by selling our interest to the co-shareholder(s), another private equity investor or an industrial buyer."
LW: "Our withdrawal is an integrated part of the company's vision for the future and is discussed fairly early on in the negotiations. Before we take a stake in the company, we need to have a clear picture of where the company is heading, so that we can adjust our exit strategy accordingly. Those plans may change afterwards, of course. The future is always subject to change."
Does private equity also have disadvantages for a company?
LW: "Not for the company: it will have extra equity available for further growth without the financial burden. Things are different for the existing shareholders, as their interest is always slightly diluted. This dilution is relative, however. After we join, the shareholders may have a smaller piece of the proverbial pie, but they can look forward to a share in a much bigger pie.
Private equity in practice: Point Chaud
In April 2014, BNP Paribas Fortis Private Equity took a minority stake in filled rolls and pastry chain Point Chaud. Let us take a look behind the scenes of this transaction.
Point Chaud was established by CEO and reference shareholder Didier Depreay in 1993. Since then, the company has expanded to become the biggest filled rolls and pastry business in Wallonia, with about 400 employees and a turnover of €40 million. Point Chaud has about 40 branches in Wallonia and France, most of which are concentrated along the Namur-Liège axis.
In April 2014, BNP Paribas Fortis Private Equity (FPE) took a minority stake in the company. This transaction was the jewel in the crown of almost two years of preparatory work. Luc Weverbergh, Managing Director BNP Paribas Fortis Private Equity, explains:
“Our entry is the result of a shift in Point Chaud's ownership of shares. CEO Didier Depreay wanted to buy out some minority shareholders, but neither he nor the company had the resources to do so. When he presented this problem to his relationship manager at our bank, which has had Point Chaud as a customer for years, he was put in contact with our team immediately.”
It still took quite some time to close a final deal. This is absolutely normal, Luc Weverbergh adds:
“Our entry is always preceded by a preparatory process, in which we evaluate the strategic plan and the figures thoroughly. We also need to come to a joint vision for the future for the company. As part of this, we proposed to simplify the Point Chaud group's structure and give it a Belgian focus. This takes time. The minority stakeholders also had to be bought out in the best possible circumstances. It was a clear advantage that we could set up the transaction ourselves without any external pressure from a corporate financial advisory, for example. This allowed us to take our time in order to build mutual trust and get to know the company.”
Supporting future growth
This participation makes FPE an important minority shareholder of Point Chaud and allowed CEO Didier Depreay to become a majority shareholder. Finance group Meusinvest keeps a small interest in the company. Didier Depreay:
"When BNP Paribas Fortis Private Equity joins the capital, it will provide powerful leverage for expanding our activities in Belgium and beyond. I am pleased about this financial partnership, as it gives us the opportunity to accelerate our development and consolidate our structure and position on the Belgian market. It should also enable Point Chaud to conquer a bigger market share faster in regions where the brand does not have a presence yet in order to become market leader in the Belgian retail segment for filled rolls and pastries. We have concrete plans for a number of new branches in Wallonia and Brussels."
Why Point Chaud?
According to Luc Weverbergh, Point Chaud has exactly the company profile FPE is looking for:
"Our investment strategy focuses on high-performance, medium-sized companies in the Benelux region with a strong market position and major growth potential. Point Chaud fits this profile perfectly. It was also clear right from the first contact we had that our vision is fully in line with the CEO's, both in terms of the choice of new markets and the company's structure, growth strategy and even a possible joint exit. This meant that all the ingredients for successful cooperation were there."
Crowdsourcing: the basics
Are you undecided about the various ways of increasing your offering? Has R&D encountered a technical problem? Perhaps your clients know more.
The concept of crowdsourcing is simple: you call for the contribution of your customers and/or the general public. An approach which is gaining popularity worldwide even though it is not actually new. As far back as 1714 crowdsourcing by the British government led to the invention of the chronometer and therefore a reliable method of calculating longitudinal position at sea.
Three hundred years later the basic principles remain the same: in crowdsourcing you work with a network of individuals and communities within and largely outside the company. They make a contribution in the form of ideas, time, expertise or financial support. This enables new solutions to be accessed and makes realisation of joint projects and optimisation of tasks possible while keeping down costs.
This system is based on exchange, transparency and communication. It also works for all sectors and at all management levels. You should be able to engage a community of designers for your product development for example and choose the best proposal together with the public. Then you will bring it onto the market, possibly even financed via crowdfunding.
The crowd is ready for this
This is certainly no science fiction, as proven by the growing success of the system. It is also the ideal time to get involved with crowdsourcing:
- communicating with the crowd is easier than ever before thanks to technological development, the social media boom and the development of online communities;
- the crowd is straining at the leash: a joint survey by several European universities showed that 54% of Europeans would like to support projects by companies and private individuals creatively and/or financially;
- co-creation, or developing a project together, is hot. The crowd can join in with a project for a whole host of reasons: the necessity for a creative outlet, commercial motives, dedication to society or just for a sense of honour or fun;
- the economy urgently needs sources of financing and innovative projects in order to achieve new growth and to increase competitiveness.
It will definitely take some getting used to as such a system radically changes the way in which a company gathers information, carries out research, produces and even finances projects. At the same time relationships with clients or users change as they evolve into potential colleagues, financiers and ambassadors.
But this does not have to be a threat. On the contrary, crowdsourcing provides you with a unique opportunity to relinquish your traditional methods. You can now look externally for ideas, get feedback from the crowd on ideas developed internally or even combine both approaches. The possibilities are endless.
The dos & don’ts of crowdsourcing
A good crowdsourcing project creates a win-win situation where the initiator and the crowd feel that they are achieving something together. How do you approach that?
In crowdsourcing the 'crowd' component is at least as important as the 'sourcing' component. In order to be successful you must build up this community and win it over. This is where the challenge lies: the crowd is not an anonymous, homogeneous mass but a collection of individuals and sub-groups. You need to seek out and mobilise each one separately. 5 tips for a powerful crowd dynamic:
Take care of the presentation of your project
Your project must appeal. Present it with photos, short films or a clear presentation – vague sketches or a half-baked concept are inadequate. Keep your explanation as simple as possible. After all not every potential funder is a specialist or an engineer.
Also, don't forget to keep your target amount as realistic as possible. Above all do not create the impression that the campaign is an excuse for personal enrichment or that you will channel the money off into other, existing projects. If you work with rewards, ensure that they are original and attractive, divided up into transparent and attainable blocks of financing.
Build your crowd
Look for the suitable crowd and get these people right behind your project. Approach them via all possible channels and assign them various roles: creative or technical input, critical analysis, ambassadorial, ... When doing so keep the threshold as low as possible, within your company as well. It is recommended that you bring as many of your people as possible into contact with the crowd in order to ensure healthy cross-pollination.
Live your project
A project without animation has little chance of success. So be motivated and keep motivating others. Respond to queries, take comments into consideration and intervene where necessary. Remember that participants cannot be squeezed to produce viable ideas. They too must go through a creative process in which they can gradually shape their input. So ensure that they continue to be involved. For this purpose it is necessary to approach each sub-group differently: encourage, win over (again), congratulate, permanently challenge, ...
Keep your campaign exciting
Keep communicating, even if some of the messages may be negative. The greater the involvement you demonstrate, the greater the loyalty of the funders and the greater their willingness to accept delays or problems.
A good dosage is important here. Ensure that news is provided at regular intervals to keep the crowd involved so the attention on your campaign does not fade away.
Your project, your rules
The principle: you decide where you want to go with your campaign while being open to suggestions from the crowd. So you lead the crowd to the desired end product rather than the other way round. Otherwise the outcome may be rather different to what you had hoped. A few examples of how not to do it are the recent – and hastily cancelled – campaigns which resulted in the product name iSnack 2.0’, a chocolate bar filled with mince, or a washing-up liquid with a scent of roast chicken...