Jonathan Simnett: Should you let private equity invest in your channel business?

Jonathan Simnett, UK director at M&A consultancy Hampleton Partners, explores the impact of private equity on channel companies and their teams

There comes time in the history of most channel firms where their founders or management decide that, to achieve their goals, they might need outside financing to expand the business faster than would be possible by using the company's own financial resources alone.

Doing this can involve anything from a short-term bank loan to selling the business in its entirety and exiting.

Each approach has its issues, not least that bank loans are dumb money adding nothing but cash to the business and selling means getting a payout but relinquishing control of the business in the short term to let someone else realise its potential.

Often, as their organisation develops, channel business owners and shareholders find themselves in a situation of 'work in progress'.

They want to realise the value of the effort they have put in to get the company to its current state and 'take some money off the table' to achieve a level of financial security, whilst accelerating the company's growth, before a final exit to start another firm, do something different or simply retire.

That is where private equity investment can make a lot of sense.

PEs exist to acquire up to 100 per cent equity stakes in businesses to help them develop so that when, eventually, their stake is sold on, to another private equity, a strategic buyer, a management by-out or buy-in or listed on a public market, the value of their initial investment is multiplied.

Why is private equity special?

Not all PEs are the same, a large group of them specialise in technology and the channel.

That being so, the right PE can offer 'smart money' - a series of benefits to a channel firm's shareholders as a partner in growing a channel business.

Whether as a minority or majority investor or a full owner with an existing management team retained after acquisition as part of earn-out deal structure.

The benefits of PE investment

What might those benefits be?

First, access to capital: PE firms, typically, have substantial financial resources, which can provide channel firms with the capital needed for expansion, acquisitions, research and development, or other strategic initiatives.

Second, strategic guidance: PE firms often employ experienced professionals either in-house or 'on their bench' who can offer strategic guidance and operational expertise to the channel, strengthening the firms and expanding their capability.

This guidance may include assistance with business planning, sales strategy, market positioning, and organisational development.

Third, operational improvement: PE firms may help channel companies identify and implement ways to enhance efficiency, reduce costs, and increase profitability.

This could involve streamlining decision making, implementing new technologies, or optimizing supply chain management.

Fourth, access to networks: PEs often have extensive networks of contacts, which can help channel firms access new customers, suppliers, distribution channels, or strategic partners.

This expanded network can facilitate business development and growth opportunities over and above what a channel firm can achieve on its own.

Fifth, professionalisation: Hard as this may be to stomach if you have been building your firm successfully for years, PE investment or ownership can require channel firms to adopt more contemporary and professional management practices and demonstrate higher corporate governance standards.

This may involve improving financial reporting, implementing robust internal controls, or enhancing risk management procedures.

Sixth, long-term growth: PE firms typically have a longer investment horizon compared to other types of external investors, such as venture capitalists or public equity markets.

This longer-term perspective can enable channel firms to focus on strategic and sustainable growth strategies rather than tactical and short-term performance metrics that may reduce the company's long-term prospects.

Seventh, talent management: PE firms may prioritise talent management within channel organisations.

They may assist with identifying and recruiting top talent, developing leadership capabilities, and implementing performance incentives to attract and retain key employees.

Naturally, this focus on talent management can help strengthen the organisation's capabilities and drive long-term success.

Lastly, exit strategy: PE investment can provide channel firms with a clear exit strategy.

PE investors typically aim to exit their investments within a certain timeframe, which can create opportunities for channel firms to pursue a sale, merger, initial public offering (IPO) or other exit option in the future.

For those firms that sell a partial stake to a private equity this offers second opportunity to cash in on retained shareholdings that should have substantially increased in value.

The price of investment

But, despite these, and more, potential advantages of PE investment, exchanging some, or all, of shareholder equity has a price.

One of the changes shareholding channel leaders need to be prepared for, and adjust to, is the potential change in the roles of the business founders and the existing board after a PE investment.

Here, it's important for leadership to fully realise and accept that some things will change fundamentally once a deal is signed.

After all, if you have sold even a minority stake it's no longer your firm to do entirely as you wish.

Before the buyout, founders typically have greater autonomy and control over the company's direction, while the board provides oversight and guidance.

After investment, founders need to engage with the reality that they will need to accept new board members appointed by the PE and adapt to a more structured governance framework that they will bring, collaborating with them and their firm to achieve agreed financial and strategic objectives.

Feel the culture

Successful collaboration between founders, the board, and PE investors is critical for maximising value creation, leveraging the strengths of each party while aligning on common goals for the company's growth and success.

That means that as well as the alignment of skills, strategy, and capital, there needs to be a close match in terms of culture.

Spend time with the entire investment team and, no matter how attractive an investment offer may be, if you don't feel totally comfortable with the individuals you'll be working with closely, walk away and look somewhere else.

Jonathan Simnett is UK director at specialist technology M&A and corporate finance advisor firm, Hampleton Partners.

He recently took part in a fireside chat at XChange 2024 with CRN UK editor Victoria Pavlova, entitled Private Equity Dynamics: Unpacking the Influence on Channel Companies, a conversation that explored the ins and outs of PE ownership.