Opportunities and challenges of private equity investment

Private equity firms invest in companies by purchasing an equity stake, usually a significant minority around 10-40%, or majority shareholding. To fund the investment, they typically combine their own capital with borrowed money, which increases the potential returns but also adds financial risk. 

In this article, we highlight the key advantages and disadvantages of private equity investment and advise when a company should consider private equity.

After the private equity investment

Once invested, private equity firms do not act as passive shareholders. They usually work closely with management, taking board seats and influencing key strategic and operational decisions. Their objective is to grow the company’s value substantially over a medium-term period, commonly three to seven years, often by improving efficiency, driving expansion and growth, or professionalising management practices. 

At the end of this period, the private equity firm seeks to exit the investment - commonly through a trade sale, a sale to another investor for example a secondary buyout, a merger, or a public offering - to realise a return on its capital.

Key advantages of private equity investment

• Access to capital and expertise: private equity can provide substantial funding for growth, acquisitions, or operational improvements, often accompanied by experienced management expertise and industry networks that can accelerate business development.
• Operational improvements: private equity firms bring proven methodologies for enhancing efficiency, implementing best practices, and professionalising operations. These improvements are often with strong alignment of interests that creates sharper focus, clearer key point indicators and greater strategic discipline for management teams, which can significantly improve company performance and market position.
• Strategic growth opportunities: investment often enables expansion into new markets, product development, or growth that would be difficult to achieve independently due to capital constraints.
• Enhanced exit opportunities: private equity backing can facilitate an eventual sale to larger buyers or preparation for a public listing, potentially maximising returns for existing shareholders who retain their stakes.

Key disadvantages of private equity investment

• Loss of control: private equity investors typically require a seat on the board and significant influence over strategic decisions, including matters that require the private equity investor's prior consent, which can potentially limit management autonomy and alter the company's culture.
• High performance pressure: aggressive return targets and shorter investment horizons can create intense pressure for rapid growth and profitability improvements, sometimes at the expense of long-term sustainability.
• Financial leverage risks: private equity deals often involve substantial debt financing, increasing financial risk and requiring strong cash flow management to service debt obligations.
• Exit timeline constraints: private equity firms operate on defined exit schedules, which may not align with your business cycle or long-term vision, potentially forcing premature strategic decisions.
• Dilution of returns: the introduction of a private equity investor reduces existing shareholders’ percentage ownership, meaning future value is shared with the new investor. This may dilute individual returns, although the overall value of the business is expected to increase through private equity backing.

Should you consider private equity?

Private equity may be suitable if your company needs significant capital for growth, would benefit from operational expertise, and management is comfortable with reduced control and performance pressure. It's typically most appropriate for established businesses with proven models seeking accelerated expansion.

However, private equity may not be suitable if maintaining full control is paramount, your business requires patient capital, or you're unprepared for the intensive oversight and performance expectations that accompany private equity investment.

For further information, please contact the corporate team.