How to Tap Private Equity

And get along with them too

From the start, entrepreneur Jeff Kober knew there was a global market for his product, a lightweight flooring material that will not ignite and give off toxic fumes in a fire. Since bringing the phenolic resin-based product to market in the late 1990s, Kober, president of Milwaukee Composites Inc., has won contracts with the transportation giants Siemens, Bombardier and Alstom, which use the material in buses and mass-transit trains.

Kober, who had used his own funds to acquire the Oak Creek, Wis. company from his former employer’s son in 2003, soon realized that the market for mass transit was far larger outside the U.S. His best opportunity was to expand overseas. “I could see it was starting to really pop,” he says. “And I wasn’t going to be able to fund it myself.”

So Kober, who had already turned to home-equity loans to fund domestic expansion of the 23-employee firm, approached local banks for the money to launch his overseas initiative, but nobody bit. “Bankers won’t take risks,” he says. “They want to have everything perfectly guaranteed.”

But Kober did not give up. He turned to private equity investors, an increasingly popular source of funding for small business. While the giants of private equity--companies like Bain Capital and Texas Pacific--garner all the attention by buying into household names like Toys “R” Us and Neiman Marcus, hundreds of smaller players in the private equity business are willing to work with small and medium-sized businesses. They certainly have the money: Private equity buyout funds—just one slice of the business¾have raised a total of $82 billion through Aug. 1, compared to $42 billion for all of last year, according to Thomson’s Buyouts magazine.

Private equity firms pool capital from wealthy individuals and institutions, such as insurance companies, pension funds and university endowments. The firms then look for companies to invest in. Most seek established, profitable companies with proven management teams. Private equity deals include leveraged buyouts, where the firm buys a majority stake to give shareholders liquidity as well as growth investments, where the firm provides capital to help an established firm grow to the next level.

Kober hooked up with Paul Stewart, a client of his corporate counsel, who is manager at PS Capital Partners, a private equity firm in Milwaukee. After about a year of getting to know each other, in September 2004, PS Capital invested $1 million in Kober’s company, in exchange for a minority interest. Since then, production has doubled and Milwaukee Composites has signed licensing agreements with companies in Korea and Japan. It’s also planning a joint venture with a manufacturer in China, Kober says. “We couldn’t have done it without that million bucks,” he says. “We would be just a small struggling company with no big future,” he said.

The bugaboo about private equity for many business owners has been loss of control (or fear thereof), but experts say, with so much money seeking deals today, sellers can get better terms. “It’s a great time for companies to be raising capital, either for the business or for liquidity for the founders. It’s a great time to be selling minority stakes in companies,” said Jeff Chambers, managing director at TA Associates in Menlo Park, Calif.

TA Associates invests in established, profitable companies. About half the firm’s investments are control purchases, where the firm acquires a 60 percent or 70 percent stake, while the other half involve minority interests, Chambers said. The firm’s average investment is about $75 million, he says.

But even when TA buys a controlling interest, the firm generally leaves the day-to-day operations to existing management. “We start by looking for management teams we think we can back and that are going to be fully engaged in continuing to run the business after we make our investment,” Chambers said. “We don’t like to buy out management teams that have made business successful. We’d rather invest with them,” he says.

The key to healthy relationships with private equity investors is to deliver results as promised. “You have to get over this fear of loss of control,” says Dan Weinfurter, chief executive of Capital H Group in Chicago. Weinfurter has depended on private equity to finance three different companies in his career. “If you execute well, it won’t be an issue,” he says.

Before Weinfurter and partner Greg Silich acquired Capital H Group, a human resources consulting firm, in May 2003, they had talked to PPM America Capital Partners, a private equity firm in Chicago, about a capital infusion that would help the company expand. While Weinfurter had other options, PPM’s offer of up to $25 million helped seal the deal, Weinfurter says.

The funds have allowed the company to reach into six new markets. Capital H has hired about 100 people in less than two years and expects revenues to triple this year to $15 million, Weinfurter says. His goal is to build a $150 million business in the next three to four years by continuing to add dedicated sales reps along with human resource consultants.

Weinfurter had the critical attribute for attracting private-equity partners: a record of success.  Previously, he had founded the Parson Group, a finance and accounting firm that was No. 1 on the Inc 500 in October 2000; Silich was former chief financial officer at ad giant Leo Burnett Worldwide.

Weinfurter says it’s important for a small company to size up the private equity partners it will be forming a long-term relationship with.

Here are some ways to find the best deals:

• Network with other business owners to identify appropriate investment firms. If your network doesn’t provide the names you need, try the Association for Corporate Growth, www.acg.org. The organization, which has 48 chapters in North America and Europe, provides networking opportunities.
  
  
• Look for more than one option. Your negotiating power increases when several firms are interested.
  
  
• Target potential investors precisely, by researching private equity firms that deal with businesses your size, in your geographic area and in your industry, Stewart says. While some private equity firms are national in scope, many prefer to work with companies in their city or region. Pratt’s Guide, published by Thomson Financial and available online at http://www.ventureeconomics.com, provides profiles of private equity firms, including amounts under management and recent investments. In addition, Galante’s Venture Capital and Private Equity Directory, published by Dow Jones, provides information on 2,300 early, mid and late-stage investment firms. Most private equity firms have web sites that list the company’s personnel, its investment strategy and a sample of portfolio companies. You want to learn how much capital the firm typically provides, how long it will commit for and how it prefers to exit.
  
  
• Prepare for the due diligence process. You will have to provide a business plan, document financial results, and describe the management team and markets. Try to look at your company from an outsider’s perspective to anticipate the tough questions. “An investor will eventually find out what’s wrong with the business as well as what’s right,” says Paul Stewart of PS Capital. It is refreshing to hear about challenges upfront, he says.
  
  
• Consider cultural fit. Finding the right match often comes down to style and values. Kober says he wasn’t interested in a firm that wouldn’t be committed to his workers. He also wasn’t interested in selling a majority stake.
  
  
• Consider the worst-case scenario. Not all deals succeed. Evaluate how you might feel about the financial partner if times get tough. Says Chambers of TA: “Ask yourself, `Is this someone I’m going to want to be working with in good times and bad?’ ”

Finally, before you get serious about going into a private equity deal, think about how you’ll get out. Private equity deals generally conclude when a company is sold to another firm, often a larger player in the same industry. Or a company can be sold to a larger private equity firm that can provide additional capital and liquidity to shareholders, Stewart points out. Sometimes, the company goes public.

Parson Group, Weinfurter’s earlier venture, was acquired in 2002 by a British firm, while Alternative Resources Corp, an IT consulting and staffing firm Weinfurter helped build with private equity funding, went public in 1994. Occasionally, a private equity firm will exit by selling its stake to the founder or current management team through a recapitalization.

Ann Meyer

Ann Meyer is a freelance writer specializing in small business topics. She writes the Minding Your Business Column for the Chicago Tribune and lives in Wilmette, Ill