The first answer one usually hears for this question is “for the company to access capital from sources other than loans and finances, which are available in the market, but require warranties and are usually attached to high-interest rates or equity investments from the shareholders”. This answer usually comes with the concept of capital, supporting the financial management of the company.
We would like to add, in a non-exhaustive way, other thinking points, and to also explore the first known point further:
- Capital and experience for inorganic growth
It is natural for the entrepreneur to always think about organic growth opportunities, which could be regarded as running the company’s core business better or more efficiently, or to innovate, in order to stand out from their competitors.
On the other hand, strategic planning for inorganic growth is usually left behind or even forgotten about. It is not common to hear from entrepreneurs about plans with the purpose of consolidating the sector in which they work, or to grow in the direction of other sectors through mergers and acquisitions. This growth plan can be achieved by acquiring competitors for geographical expansion, clients or a range of products and services increase. It can also be focused on complementary businesses, in order to obtain synergies in the value chain, vertically (with suppliers to integrate the production chain, for example) or horizontally (with non-competing businesses, to increase the product/service offers, according to the client’s needs, for example). In all of the aforementioned situations, the goal is to complement organic growth and to accelerate business development, through economy of scale, reaching a more powerful and stable company.
With this in mind, it could be interesting for the partnership to bring an experienced investor with a merger and acquisition background, who will be able to contribute to the execution of the consolidation strategy, regarding the target companies tracked by the entrepreneur. Following the first consolidation movements, the investor will also be able to collaborate in the targeting, selection and negotiation processes for new target companies. The capital brought by the investor will also allow the company to accelerate its growth strategy, compared to what would be possible with only its own cash flow.
Mergers between companies are another option within inorganic growth opportunities. It could be a result of conversations between competitor entrepreneurs, in which both agree that a combination of the businesses would bring gains for the two companies. It isn’t rare to see situations in which (i) relative valuations of the businesses could generate unbalanced ownership, sometimes different from what is expected by the shareholders, or (ii) to obtain the synergies that will generate better results, more cash investments would be needed for the merged company. In these situations, cash brought by private equity funds is an additional resource for the business, allowing it to balance the shares and/or to maintain enough cash for the growing necessities.
- Reduction of the entrepreneur’s risk regarding the business
In most cases, the entrepreneur has the largest amount of cash invested in the company. From a portfolio investment perspective, the amount that the entrepreneur has in the company is highly elevated to be in only one asset. Additionally, his/her savings might end up being used in situations of cash injection needs in the company. Cash brought by the investor can be useful in this situation, so that the other financial resources of the entrepreneur are not compromised with the business.
In some situations, the financial investor also has the option of bringing in a combined investment, which includes a cash-in operation into the company’s capital structure and a cash-out operation from the entrepreneur’s bank account. Considering this, the entrepreneur won’t only rely on the company’s results and will be able to invest in other assets.
As we do not want to take any longer, we will bring three other interesting possibilities to bring in money from private equity investments in the next edition of Imeri Insights: (i) succession planning, (ii) partnership restructuring and corporate governance implementation, and (iii) cash for growing.