The Private Equity Advantage: Ready, Set, Grow

Introduction

Private Equity (PE) plays a crucial role in helping businesses achieve growth. Consider the case of Burger King, a 55-year-old publicly traded burger chain that faced severe challenges, including declining customer traffic and earnings amidst the recession. In 2010, 3G Capital, a Brazilian PE firm, acquired Burger King for approximately $3.3 billion ($4 billion inclusive of debt). By shifting to a franchise-based model, slashing operational costs, and injecting fresh energy into brand innovation, 3G Capital did not just revive Burger King—they supercharged it. By 2012, earnings had surged by 49%, setting the stage for a merger with Tim Hortons in 2014 to create Restaurant Brands International. By 2017, 3G Capital and other shareholders had realized over $14 billion from the turnaround.¹ This story showcases how PE can drive substantial business recovery and growth.

Understanding Private Equity

Private equity involves investment partnerships that acquire and manage businesses with the goal of selling them for a profit. These firms operate PE funds on behalf of institutional and accredited investors, making significant investments in private companies or acquiring public companies entirely. Like mutual funds or hedge funds, a PE fund pools the money invested by all the investors and uses that money to make investments. However, PE firms differ in their focus on long-term investment opportunities, typically holding assets for 10 or more years.²

PE strategies usually involve taking a controlling interest³ in a company that is not publicly traded. This company, known as a portfolio company, benefits from the active management and direction provided by the PE firm to increase its value. PE provides medium to long-term finance in return for an equity stake in potentially high-growth unquoted companies.

The key to PE's growth and high rates of return lies in its practice of buying businesses, guiding them through a transition of rapid performance improvement, and then selling them. This approach combines business and investment-portfolio management and is central to PE's success. Selling or spinning off a business is seen as the culmination of a successful transformation, not as a strategic error.

Key Characteristics of Private Equity

• Investment Focus: PE firms tend to invest in mature companies rather than startups, aiming to enhance their value through strategic management and operational improvements.
• Capital: PE investments are primarily funded by equity commitments from external investors, which include high-net-worth individuals and institutional investors such as pension funds, insurance companies, and endowments. To enhance potential returns and increase the capital available for investment, this equity is often supplemented by leveraged financing—commonly in the form of debt.
• Fund Term: PE funds typically operate with a finite term, usually ranging from 10 to 12 years, and are structured into distinct phases. These include the fundraising phase, during which capital is raised from investors; the investment period, where funds are allocated to portfolio companies; the management period, during which these investments are actively managed and optimized for growth; and finally, the exit phase, where investments are sold off, and returns are distributed to the investors.
• Management Structure: PE funds are managed by general partners (GPs), typically the PE firms that establish the funds. Limited partners (LPs) are the investors in the funds, with limited liability.
• Types of Acquisitions: Common PE deals include buyouts (acquiring entire companies), carve-outs (purchasing divisions of larger companies), and secondary buyouts (buying companies from other PE firms).
• Management and Value Creation: PE firms overhaul acquired companies by implementing cost cuts, restructuring, and leveraging their expertise to boost value.

The goal is to exit the investment profitably within a set timeframe.

Value Creation Strategies

PE firms use various strategies to enhance the value of their investments:

1. Strengthening the Management Team: PE firms often bring in experienced executives or support existing management to improve leadership and operational efficiency.
2. Acquiring New Businesses: Growth through acquisitions is a common strategy. By acquiring complementary businesses, PE firms can expand operations, enter new markets, and achieve synergies that lead to cost savings and increased efficiency.
3. Shaping Business Strategy: PE firms develop strategic plans to position the businesses for long-term growth. This involves adjusting market positions, targeting new customer segments, and allocating resources efficiently to capitalize on growth opportunities.
4. Streamlining and Improving Operations: PE firms focus on reducing costs, improving processes, and leveraging technology to enhance productivity and quality, resulting in significant cost savings and higher profitability.⁵
5. Optimizing Capital Structure: PE firms manage debt to reduce interest expenses and improve cash flow while leveraging equity to fund growth initiatives sustainably.

These strategies collectively drive significant improvements in performance, market position, and profitability, benefiting both the portfolio companies and the investors.

Implementing Sustainable Growth and Navigating Challenges

Despite the perception that PE primarily aims for short-term gains, many firms in this sector play a crucial role in not just facilitating immediate recovery but also nurturing long-term sustainable growth for their investments. This approach is evident in several key examples that demonstrate a commitment to both immediate and extended objectives. US PE firm, Warburg Pincus's investment in Poundland is an example of PE fostering long-term growth. Rather than chasing quick returns, Warburg Pincus focused on building a robust infrastructure for Poundland, resulting in substantial profitable growth, and culminating in a successful launch on the stock market. Similarly, African Capital Alliance's (ACA) investment in MTN Nigeria (MTNN) through its PE funds demonstrates a commitment to long-term goals. ACA's involvement helped MTNN increase its value by over 3,100%, while facilitating capital financing and strategic cost-cutting, and fostering social responsibility through investments in education, economic development, and healthcare in Nigeria.⁷

Balancing Short-Term Gains with Long-Term Goals

PE firms often grapple with the challenge of delivering quick returns to satisfy investors while ensuring the long-term growth of their portfolio companies. This balance is typically achieved through a strategic mix of immediate operational improvements and long-term investments in innovation and market expansion. TPG's investment in C3.ai illustrates this balance. Initially, TPG focused on streamlining operations and enhancing go-to-market strategies to stabilize the company financially. In parallel, TPG supported C3.ai's long-term strategy to become a leader in AI applications, ensuring the company's enduring market relevance and growth.⁸ This example reflects a comprehensive approach where PE firms strategically balance short-term achievements with long-term ambitions, fostering robust growth trajectories that extend well beyond the immediate horizon.

Attracting Private Equity Investment

For companies looking to attract PE firms, understanding what these investors seek is crucial. PE firms typically look for businesses with strong potential for growth and value creation. Here are some steps companies should take to become attractive to PE investors:

1. Strengthen Corporate Governance and Compliance: Effective corporate governance is crucial for attracting PE investment. Ensuring that governance practices are transparent and aligned with legal standards can significantly increase a business's appeal to investors. Additionally, companies must be vigilant in complying with all relevant local and international regulations, including conducting regular compliance audits.
2. Optimize Legal Structures for Investment: Reviewing and optimizing the legal structure of the company can make it more attractive to PE firms. This might involve restructuring subsidiaries, addressing potential legal liabilities, and ensuring that the corporate structure supports the potential entry of a PE investor.
3. Incorporate ESG and Green Technologies: The role of Environmental, Social, and Governance (ESG) factors in PE investments has grown in importance. Companies should integrate ESG criteria into their business operations and invest in green technologies to attract PE investors.
4. Develop a Clear Growth Strategy: PE firms look for companies with a well-defined growth strategy, including plans for market expansion, product development, and strategic acquisitions. A clear and achievable growth plan can make a company more attractive to investors looking for substantial returns.⁹
5. Prepare for Due Diligence: PE firms conduct thorough due diligence before investing. Companies should be prepared to provide detailed information about their operations, financials, market position, legal compliance and growth prospects. Ensuring that all documentation is accurate, up-to-date, and readily accessible will facilitate a smoother due diligence review and signal a well-managed organisation to potential investors.

By focusing on these areas, companies can position themselves as attractive targets for PE investment, potentially unlocking new opportunities for growth and development.

Future Trends and Predictions

As global economic landscapes and technological advancements evolve, PE is expected to shift significantly towards renewable energy, technology infrastructure, and healthcare innovation. These sectors are increasingly attractive due to climate concerns, rapid digital transformation, and the need for healthcare advancements. PE firms will align more closely with global economic changes and societal shifts towards sustainability and technology. This alignment will shape their strategies and focus areas, steering them towards opportunities that promise both financial returns and broader positive impacts. As these trends take shape, investments will likely prioritize sectors addressing critical global challenges and driving long-term growth.

The Strategic Advantage of Private Equity

PE plays a crucial role in the investment world, providing opportunities for substantial returns and transforming companies. Beyond these strategic advantages, PE investments contribute significantly to the broader economy by creating jobs and driving economic growth. For businesses needing revitalization and investors looking for significant gains, partnering with PE offers not only a strategic advantage but also a pathway to support the overall economic ecosystem. Embracing PE can differentiate between stagnation and dynamic growth, making it a wise choice for those aiming to thrive in today's competitive and ever-evolving market. Supporting Businesses Through Private Equity Investments

At SimmonsCooper Partners, we understand the challenges businesses face in attracting private equity investments and ensuring compliance with the law. For more insights or to inquire about our private equity related services, please contact Oluwadara Omoyele at oluwadara.omoyele@scp-law.com or info@scp-law.com.

Footnotes

1 'Private Equity Case Study: Burger King' (October 20, 2023) - Private Equity Case Study: Burger King and 3G Capital (valueaddpe.com)

2 'Private Equity Explained with Examples and Ways to Invest' (April 10, 2024): https://www.investopedia.com/terms/p/privateequity.asp

3 A shareholder has a controlling interest in a business when they own more than 50% of the company's shares. This majority ownership grants them the decisive influence in shareholder meetings and control over the company's strategic direction.

4 'The Strategic Secret of Private Equity'- https://hbr.org/2007/09/the-strategic-secret-of-private-equity (accessed May 23, 2024)

5 Kyle Wilson: Unlocking Liquidity to Enhance Private Equity Portfolio Returns: The Non-Bank Lending Advantage (April 18, 2024) - https://ecapital.com/blog/unlocking-liquidity-to-enhance-private-equity-portfolio-returns-the-non-bank-lending-advantage/

6 'Warbug books 4.5x on Poundland' (March 12, 2014): https://www.privateequityinternational.com/warburg-books-4-5x-on-poundland/

7 https://acagp.com/our-business/private-equity/mtn-nigeria-communications-ltd/

8 'C3.ai Raises $100 Million' (January 17, 2018): https://c3.ai/c3-iot-raises-100-million/

9 Talmor, E., & Vasvari, F. (2011). International Private Equity. John Wiley & Sons.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.