Security Solutions M&A Update – January 2024
December 28, 2023
Air, Land, Sea, & Space Systems M&A Update – January 2024
February 28, 2024Articles | Feb 14, 2024
Is Minority Stake Equity Investment the Ideal Solution for Founder Liquidity?
Maximizing Returns: Leveraging a Minority Stake Equity Investment Strategy for Dual Gains
What if Selling Isn't Ideal, but You Need Capital Without Losing Control?
For business owners and operators navigating uncertain market conditions or eyeing substantial growth potential in the near future, a two-step sell-side process offers an attractive alternative. By initially bringing on a minority stake equity investor, you can secure capital without sacrificing control.
The Influence of Market Dynamics on a Sell-Side Process
As we step into 2024, market participants are cautiously optimistic. Public valuations closed 2023 on a robust note, inflation remains under control while growth persists, and there's growing confidence among investors that the Federal Reserve (Fed) will soon implement rate cuts.
For private business owners, these developments offer favorable conditions for the merger and acquisition (M&A) landscape, which has seen two consecutive years of decline. Many of these owner-operators are likely to view 2024 as an opportune moment to pursue a liquidity event.
Amidst the considerations outlined above, other business owners and founders are grappling with lingering tail-risk scenarios. Ongoing conflicts in Europe and the Middle East, coupled with shipping disruptions in the Red Sea, contribute to a geopolitical landscape fraught with volatility. These factors pose the risk of supply route disruptions and fluctuations in oil prices.
Furthermore, in the U.S., the upcoming presidential election introduces significant uncertainty regarding fiscal and foreign policies. Even as these factors may be regarded as background noise, they have the potential to curtail or delay the current market recovery.
Moreover, while the S&P 500 index levels have rebounded and are hovering near all-time highs, the LTM P/E (last twelve-month price-to-earnings) ratio of the S&P 500 has yet to fully return to pre-2022 levels.
Amidst these dynamic market conditions, some business owners and operators may hesitate to initiate a traditional sell-side process. Likewise, those who anticipate significant growth opportunities unfolding in the next two to three years may find a two-step sell-side process to be an appealing alternative.
Embracing Two Bites of the Apple – Introducing a Minority Stake Equity Investor
The two-step process, often referred to as "two bites of the apple," empowers a business owner or founder to partner with a minority stake investor, unlocking liquidity for a portion of their ownership while retaining the flexibility to invite additional investment to fuel accelerated growth. As the business matures and achieves a more robust margin and revenue profile, the owner retains a majority stake, positioning them to pursue a full liquidity event—a second bite of the apple.
This approach offers several advantages:
-
Enhanced Combined Liquidity: By partnering with a strategic investor, business owners can capitalize on stronger growth and multiple expansion, resulting in a more substantial combined liquidity event.
-
Opportunistic Pricing: The majority of the liquidity can be realized at a more favorable time in the capital markets, optimizing returns for the owner.
To illustrate, let's consider the following scenarios for ABC Company:
Scenario 1: ABC's founder sells the entire company today, receiving total equity value of $160 million.
Scenario 2: ABC's founder opts for a two-step process, securing partial liquidity and leveraging a financial partner to accelerate strategic growth. By scaling the business until 2027, the founder exits the remainder of their stake at a higher EBITDA threshold and exit multiple, resulting in a net-present value on equity surpassing that of Scenario 1. Notably, the two-step process yields $280 million in proceeds for the owner, compared to $160 million in Scenario 1—an impressive 75% increase.
Frequently Asked Questions from Founders Considering a Minority Stake Equity Investor
- Will I maintain control of my business?
- Yes, for founder-owned companies, the answer is typically yes. A minority stake investor aims for <50% ownership, allowing the founder to retain control. However, the investor may secure certain protective provisions, such as approval rights for significant business changes or board representation. A sample term sheet detailing these provisions is provided below. - Do private equity investors provide strategic value?
Yes, the private equity market, especially minority stake equity investors, offers investors who bring operational and financial expertise to their portfolio companies. Some even offer in-house consulting or data teams to augment the workforce of their portfolio companies. - Will a minority stake investor seek to increase financial leverage?
- No, as a minority stakeholder, the investor cannot alter the company's financial profile without the owner's consent. Additionally, minority stake equity investors typically prioritize operational enhancements over financial engineering. - Which investors specialize in growth investing?
- The landscape of funds focusing on minority positions has expanded steadily. In 2023 alone, there were approximately 1,400 growth transactions involving over 3,000 investors, according to PitchBook data.
Exploring a Minority Stake Investment Opportunity for Your Business
In essence, there exist several avenues for achieving liquidity in a founder-owned enterprise. For founders who envision greater opportunities emerging in the next two to three years, opting not to sell their entire company at present—especially amidst potential expansions in multiples—may be a strategic choice. In such scenarios, founders may contemplate selling company shares ahead of an exit, often referred to as a minority stake equity sale or secondary sale. This approach fulfills liquidity requirements while paving the way for future company growth before eventually pursuing an exit when multiples are more favorable.
Should you have any inquiries, ESF Equity, LP's Equity Capital Markets Advisory Group stands ready to assist. With a track record spanning back to 1999, our team specializes in raising equity capital for growth-oriented enterprises, spanning from mid-stage ventures to established middle market firms. Collaborating closely with the firm's industry-specific M&A teams and other service divisions, we ensure clients receive extensive market coverage and innovative solutions for intricate scenarios.
To initiate a consultation with our team, please feel free to reach out to us.
February 14, 2024