Private Equity Investors

By Sam Vinson and Ladd Hirsch

In his famous “To Be or Not to Be” soliloquy, Hamlet anguished over whether his future was worth living. [1] Hopefully, private company founders picture a future less bleak than Hamlet’s grim outlook. When the founders of fast-growing private companies accept new investment capital, however, they need to consider the future of the resulting ownership structure of the business, particularly when the financing involves issuing new company shares.

When a private equity investment is made in a private company, a balance must be struck between the competing interests of the company’s founders, on one hand, and the private equity or venture capital firm (the “PE investor”) on the other. From the PE investor’s perspective, an investment in a private company makes sense only if the founders maintain their continued commitment to the company’s success. Once the investment is made, founders will want to make sure they have an exit plan in place that provides them with ample rewards when they depart based on the financial success (hopefully) they helped the company to achieve.

This balancing of interests between founders and PE investors is often handled through a vesting process regarding the founders’ stock or equity ownership. This post, therefore, focuses on the use of vesting schedules by private companies when issuing stock. Ideally, the use of vesting schedules that apply to stock ownership is complimented by buy/sell exit planning, i.e., founders will want to secure some type of a buy/sell agreement that permits them to monetize their interest in the company at the time of their exit.
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Part 1 of this series focused on how private company owners can make their businesses attractive to private equity (PE) investors like those on the hit TV show “Shark Tank.” The discussion picks up after the PE firm has made its investment and the Post considers what steps private company owners can take to get the most out of their business relationship with the PE investor.

As a starting point, it is critical for the business owner to appreciate that PE firms are not lenders, and that a PE investment is not similar to a loan.  Lenders want to be sure that the company operates efficiently enough to repay the debt with interest.  By contrast, by investing in the business, PE investors secure an ownership stake in the company, they are seeking to achieve a much more robust return on their investment than simple interest, and they will be much more hands-on regarding the company’s business plan, operations and financial performance.
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For years, use of the term shark in a business context referred to unsavory characters such as shady lenders, sketchy lawyers and unscrupulous business people.  More recently, the success of the hit reality TV show “Shark Tank,” has given sharks a Hollywood make-over, and a more positive image.  The Shark Tank show features small business owners as contestants who present their needs for capital to a panel of rich investors (the sharks), including Dallas Mavericks owner Mark Cuban.  Larger companies also need access to capital at times to fuel their growth, and this Post focuses on the ways business owners can make their companies attractive to private equity investors (the sharks).
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