What exactly is Private Equity?

Let's say you have grown your clothing manufacturing company to 50 people and $5 million in revenue.  You take much pride in the fact that people say your company is worth a million dollars.  You do the hiring, the firing, the bookkeeping and the sales.  You are working 75 hours a week. You know there has to be a less expensive way to bring your clothes to market, and a better way to reach to the tech savvy generation.   Orders are growing, but you know are missing opportunities because you can't find ways reduce your costs and create more product.   You have outgrown your banking relationship and feel you need money and help to grow your business in a way that makes sense and feels right.  But you feel stuck.

If you are male, chances are another man will suggest you speak to a private equity investor. But if you are a female? Chances are you will never heard those words, and you may continue to struggle.

In 2004, the Kaufmann Foundation published a groundbreaking study that illuminated the "extraordinary challenges" facing women entrepreneurs...securing the funding that would facilitate growth. The ‘Diana Project' found a substantial venture and private equity funding gap between male and women led businesses; a gap that limits women's opportunities to create high value companies. 


The reason for this funding gap? A dearth of women in the fields of private investing, which in turn leads to a lack of knowledge about the benefits of private equity.

As a Managing Director of VAST, an equity investor targeting the opportunities of women owned and led businesses, I am often one of only a handful of women in meetings focused on private investing. The men around me speak a language that is foreign and off putting to women who, like me, built successful companies. Until just a year ago the terms ‘Angel,' ‘VC,' ‘LBO,' ‘mezzanine,' ‘exit' and ‘ LP'" meant nothing to me.  I suspect that they may also mean little to many of Utah Pulse's male readers as well. To help level the playing field, I'll go though the very basics of Private Equity investing.

What is private equity?

The term ‘private equity' covers a broad range of methods to finance commercial ventures in ways that do not involve publicly tradable assets like stock or bonds.  The term can be applied to a whole host of investment strategies including venture capital, growth and mezzanine capital, angel investing, and private equity funds.

The basic goal of all private equity investors is to make money.  They do this by investing their and other people's money in a company in exchange for a substantial interest (or ownership). This allows the investors, known as ‘Limited Partners' or LPs, to influence how the company is run through the fund's leadership, or Managing Directors.  The Managing Directors, for example, usually take a seat on the board of a company that has received an investment.  The Managing Directors and their staff, who often have specific expertise in things like finance and marketing, work closely with the owners to increase the value of a company.  They finance this time through a ‘management fee' that is charged to the investors.  The PE firm in essence invests expertise as well as capital (often called ‘value add') so it can sell off its investment and return substantially more money to their LPs than they put in. Most of the time the Managing Directors are also LPs in their fund, so the incentive to succeed are high. 

Although the lines are getting more blurred, different types of private equity are commonly used at different stages in a company's life. Utah has a very active ‘Angel investors' network, where wealthy individuals, usually friends, group investments together for a company one of the Angels has found. Venture Capital is often used when a company is in ‘start up' phase. These funds can help take an idea from the basement to launch and though a period of growth. Many of these companies fail, so VCs typically have a higher tolerance for risk than other private equity investors.  Growth equity investors, like VAST, usually involve minority investments (i.e., not ownership) in companies that have proven themselves and need capital to expand, retool their operations, enter new markets or finance a major acquisition, like a piece of technology, without a losing a controlling interest the business.

All private equity investors take a share of the company in exchange for capital and work with (or sometimes against) the other owners to make the business attractive for sale.

That scenario sounds callous. Come in, take over, maybe even fire the entrepreneur, sell the company and walk away with money.  Women often create businesses to enhance their independence and to give them more control over their work life, and some have told us that they thought of losing control over something they have fought hard for and nurtured feels counter intuitive.  Handing over that all that effort and success to a group of (male) Managing Directors has little appeal.

My partners at VAST and I believe that private investing can help women and their businesses and should be considered carefully by women who want to grow their companies. Private equity firms like ours help companies by strengthening their leadership team, not by shunting them off to the side. They can help grow the company soundly and successfully by building on its strengths and addressing its weaknesses.  We and most PE firms believe in working in partnership with the existing leadership to refocus strategy, identify new markets, find efficiencies and create growth initiatives. Sometimes it even makes sense to sell a portion of the company so that the team can focus on the part that has the best potential.  Making all these decisions on your own can be daunting. That is why when it works well private equity uses capital very efficiently and effectively to grow companies -- and the economy.

Who invests in private equity and venture capital funds?

People who make investments of this kind are called ‘qualified investors.' This means that they are individuals who have a substantial amount of private wealth, at least $200,000 a year in income and several millions more in net assets. These are risky investments, and the assumption by the SEC is that qualified investors can afford to lose their investment.  Institutions like banks and pension funds also invest through PE and VC funds as well, and if these institutions want to diversify their portfolio of private equity funds they can invest in a ‘Fund of Funds'. These funds in turn invest in companies like VAST. We are proud that Zions Bank is an institutional investor in our fund.

What kinds of investments are made?

The most common form of investment is a cash investment in exchange for part of ownership in the company. Some funds seek an ‘ownership position,' meaning they own at least 51% of the company, while others, like VAST, seek a ‘minority ownership position,' often with the added bonus of having first crack at stocks when the company is sold, called ‘preferred equity.'  Funds can be invested one time only, or the firm might decide to invest more money as the company grows. Sometimes more than one firm invests in a company at the same time, especially during times of expansion and growth, and the company is then said to ‘raise a round of funding.'

How do PE and VC firms make their investors money? What about the women who started the company?

Two words: ‘Exit strategy.'  Even before an investment is made, a PE firm as part of its ‘due diligence' research is thinking about the ways the company can grow and become more attractive to others. Private equity firms get the ‘ROI' or return on their investments a few common ways. They can do an ‘Initial Public Offering' or IPO where the company creates and sells stock to the public.  If you Google the now famous 2004 IPO for Google, for example, you'll find they initially offered shares the public at $85, and by the follow on, or second, round of funding, the price grew to $295 a share.  PE investors can locate a larger company willing acquire the company; these ‘mergers or acquisitions' can be for cash or shares in the buying company.  Alternatively the company can in essence buy the investors out through a ‘recapitalization.'

For the business woman whose company has received private investment funds the financial returns can also be substantial. 

Remember our exhausted entrepreneur? Her company has $5 million in revenue and is valued at a little over a million dollars.  She still loves the business and doesn't want to retire quite yet, but she can't seem to get the company to the next level.

Private equity just might be her answer.   She agrees to a $500,000 capital infusion in her company in return for a 40% stake, preferred stock options, and a seat on the board.  The PE firm helps her find a Chief Financial Officer who locates $100,000 in efficiencies in her first year on the job.   The firm's Managing Directors leverage new international supply chain relations, reducing her costs, and introduced her to a channel marketing firm, greatly increasing the visibility of her product.  Things really start happening, and the PE firm helps guide her through a five year period of growth.  Now her company, once valued at $1 million, is worth $25 million.  The PE firm helps introduce her company to others, and one offers to buy the company for $27 million. Because the entrepreneur retained a 60% ownership her $1 million is now worth over $16 million.  It might be time for our entrepreneur to kick back...or move on to her next great idea!

To learn more about VAST go to our web site www.vastequity.com.

Barbara Zimonja is President and CEO of Premier Resorts and is the most recent member of the University of Utah's David Eccles School of Business Hall of Fame.