You want a money miracle?

The vast quantity of cash flowing into private equity firms from super funds is giving the firms a taste for big deals and leaving smaller companies scratching around for capital. To get venture capital and expansion capital, SMEs have to work hard. By MI

By Mike Preston

Sixteen years of strong economic growth and the superannuation bonanza have left the coffers of private equity firms and rich investors overflowing. But while newspapers are filled with news of billion dollar deals at the top end of town, observers of the market say the flow of funds to businesses below the $25 million revenue mark is much more limited.

A good product, technology or service can be the cornerstone of a good business, but it may not be enough to bring in investment.

Some businesses get lucky or are so well-connected, they get rich individuals supporting them (see “Getting money to grow: How to get money from the rich and famous” in our Growth Resources section) but for the rest trying to entice a private equity or venture capital firm to invest, they must have the right contacts, outstanding management, in-depth planning and more.

Peter Devine, chief executive of venture capital firm Uniseed, says one of his firm’s recent investments, the Queensland-based hydrogen storage technology company Hydrexia, exemplifies the sort of business that will often pull in the investment dollars.

“They could show their technology had a lot of advantages over competitors and, although there was some need for development, they persuaded us there were clear growth prospects here and overseas,” Devine says. “But almost as important was that they put a good business plan together and were led by someone who knew the industry, had the contacts, and understood the commercial issues.”

Money money money

Australian private equity and venture capital firms raised more than $4 billion and invested just under $2.3 billion in the 2005-06 financial year, according to a Thomson Financial/Australian Private Equity and Venture Capital Association (AVCAL) survey.

AVCAL chief executive Katherine Woodthorpe says this level of activity is sure to increase in 2006-07. She says private equity giant Pacific Equity Partners has already announced plans for a $4 billion capital raising for one fund alone.

However, private equity fund managers say that as the amount of money available for investment rises, funds prefer to do deals at the big end of the market to increase the returns achieved for each deal.

Richard Abraham, a director of Allen Capital Private Equity, says his firm, which remains at the smaller end of the investment market, has increased its investments from $3 to $6 million to a minimum $20 million this year.

“The amount of money that has been poured into private equity recently means a lot of managers are rising up above the SME market,” Abraham says. “There are a lot of private equity managers who previously operated in the SME market who, because of the magnitude of recent fund raising, are moving towards the larger end of town.”

As for venture capital – seed and very early stage investment – there had been a significant pickup since the bursting of the dot-com bubble in 2001 devastated capital raising at that level. But the levels remain low according to the Thomson Financial/AVCAL report. In 2006 venture capital funds raised just $34.5 million, well below even 2001 levels.

Show me the money! How to attract interest from private equity investors

Each private equity or venture capital fund has its own investment philosophy. However, the fund managers and corporate advisers SmartCompany spoke to identified several fundamental qualities business must have in order to attract investment:

1. People, people, people

Standout management was the leading factor most fund managers said they look for when considering an investment.

Bob Beaumont, one of the founders of the business angel movement in Australia and an adviser for the Federal Government’s Commercialising Emerging Technologies (COMET) program, says: “The rule that floats above all else is that great teams always beat great technology – a well-led team, balanced, flexible, that can scale up if required, multi-skilled – if you’ve got that then you’ve half a chance of attracting investment.”

2. A good strategic plan – that is realistic

Investors want to know where your business is going to take their money; and for that you need a plan.

“A good strategic business plan that looks at what a businesses prospects are over the next five years in a realistic way is crucial,” says Accretion Investment Management chief executive Peter Chapman.

“The most common mistake people make is getting overly optimistic about the speed at which they’ll be able to grow their business and sales,” he says. “Conservatism in growth projections is important, if business owners put wildly optimistic propositions to private equity players that really undermines their credibility.”

3. Lock in the systems

Many SMEs have grown up around the passion and commitment of their founders. This can present a risk for private equity investors; they need to be reassured the business won’t fall apart if the entrepreneur behind the business moves on.

According to David Knowles, the head of Pitcher Partners’ business evolution practice, SMEs targeting investment put systems in place so they can show that when the owner goes, earnings endure. “Lock in customer and supply relationships with contracts, lock in staff, make sure IP is solid and reliable. The more certain profit flows are into the future, the more a business is worth to investors.”

4. Good advice

PricewaterhouseCoopers’ head of corporate finance, Greg Keys, says: “Many SMEs aren’t capable of modelling a transaction from a leverage point of view or of anticipating the kind of things private equity looks for, and advisers can help them with that.”

Hawkesbridge Private Equity executive director David Plumridge agrees. “For people looking at attracting private equity, investment professional advisers are usually a good idea cause they know what investors are looking for. As a business owner you usually only do one sale in your life, so it’s best to work with someone who does it on a regular basis.”

5. Presentation

The make-or-break moment for any business owner attempting to bring in investment is the pitch. Nanyang Ventures’ executive chairman, Chris Gollis, says. Especially at the venture capital level, the pitch for investment needs to be short, sharp and focused on the financial bottom line.

“You need an effective 15-minute, 15-slide presentation, and always remember what the investors you’re talking to are interested in: how much do you need, how much are they going to make, what are the risks. Even 30 minutes of detail can be too much,” Gollis says.

6. Where’s the exit?

It doesn’t matter how good a business looks, investors won’t be interested if they can’t see a way to get their money out.

Uniseed’s Peter Devine says investment seekers should map out the exit options for potential investors and provide evidence of their viability.

“A business can say ‘we’ll do a trade sale’, but they need to go beyond that and show this is an industry where a trade sale is possible, there’s a history of it and these are some possible buyers,” he says.

There is a lot of money out there, but making it flow to your business can be a challenge. Private equity and venture capital investors are highly savvy people and they don’t give second chances lightly, so if you’re seeking investment, make sure you’ve put in place the key things investors want to see.

 For a list of firms that provide venture capital and early stage investment, click here and scroll to the end of the page.