A slice of a bigger pie

Instead of bemoaning a lack of expansion capital, business owners might consider taking an equity partner.

A slice of a bigger pie

A serious constraint on growth is the lack of capital. People who own businesses often feel that getting it to the “next level” is going to be hard without a decent bank balance. They feel caught in a Catch-22 situation. “I could grow if I had the capital but I can’t get the capital unless I grow.”

One way around this problem, particularly at the moment with the world awash with liquidity, is to both sell and keep the business or, in other words, take in an equity partner while retaining some shareholding. This helps both with the balance sheet and with important secondary financial credentials such as guarantees.

Naturally, there are risks with such transactions as there are with walking across the road, and one has to be careful in selecting an equity partner of the many who are out there in the marketplace today. Doing due diligence on an equity partner should be as important to the seller of equity as it is to the buyer.

However, once satisfied to the extent that one can be these days, the rewards can be substantial. If the reason for taking on an equity partner is to get access to capital so that the business can grow, it is important to have in place a business plan that demonstrates the benefits of the capital injection and the surrendering of some equity.

If the business plan indicates that despite the growth, the income to the seller is going to be less than would be the case without a sale and that any appreciation in the value of shares will not compensate for surrendering equity, then the clear indications are not to sell.

The positive indicator for taking in an equity partner is the business plan that indicates the growth will result in an increase in income to the seller, coupled with an increase in the value of the seller’s shares. In other words, the benefit to the seller is that his or her income goes up as well as the value of their shares.

The business plan should give them some confidence that over a period of time they should be looking at the value their retained shares being worth more than the total value of the shares before taking on an equity partner – that their portion is now worth more than the whole was previously.

The business plan should also give them some comfort that the income from their reduced equity will be greater than their income before selling. In other words, the growth promised by the injection of equity has to make sound financial sense and meet certain financial objectives that are acceptable to the seller.

Taking in an equity partner can be of far greater benefit to the owners of a business than an outright sale. With the outright sale, that is it – the door has closed. However, by staying on for the ride with an equity partner, the possibilities can be enormous.

Having said that, there is no certainty in commercial transactions. Predicting what might happen in markets tomorrow lacks precision; the uncertainty increases as the period of the predictions increases. Conservative projections, which should include prudent risk factors, will help against foolhardy decisions.

By not expecting too much and by being intensely inquisitive about the equity partner, while having a growth business plan that meets the fundamental criteria of increasing income and share value, it is unlikely that the prudent seller will get into too much trouble.

Too frequently people who have built up a great asset over time are tempted by the cash-in-the-hand trick. They often say that the offer was too good to be true and as the saying goes…

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