Should You Take the Money Now?

With the reported record $100B of dry powder that private equity funds must deploy in 2013, it seems logical for a growing company to partner with a financial investor right now.  While the surplus cash can lead to favorable terms,  is it better for an entrepreneur to wait ?   Or does the current frothy investment appetite make it an ideal time take the private equity plunge?

Generally speaking, delaying a sale is better.  From a financial standpoint, valuations tend to accelerate as a company grows.  In a good market, a $1M bottom line may yield a $4M valuation (4x); but doubling the bottom line might yield a three times better valuation ($12M).  Thanks to "multiple expansion," a dollar of cash flow is worth more as an enterprise grows.  There are many factors as to why, but the primary reason is an increased supply of money available for larger deals.  There are also other critical factors that tend to work in your favor as a bigger concern, such as negotiations around corporate governance and control issues.

However, outside of price, there might be business reasons why it's better to bring in financial sponsors now.  PE firms are very well connected and good at scaling businesses.   They also can help mitigate risks such as competitive threats or large capital investments that an entrepreneur may not want stomach on his or her own.  PE shops are also good at building seasoned management teams and helping to grow company infrastructure.  If any of these areas are critical to the success in the near term, than it might be the right time for a partnership.

Of course, the timing alone is not the only consideration for taking institutional equity.  According to that same Bloomberg article, over 1/4 of PE firms are expected to fail.  Diligence around the track record of a firm is key; If the firm is not around for the second bite of the apple, then the lofty valuation on the front end doesn't mean as much.  Also, goal alignment is also important.  For example, private equity is not "patient capital."  Your business will be sold to the highest bidder at some point in time.  There's no emotional ties to the business and the clock starts on day one.

Current private equity valuations certainly offer an attractive way to deepen your company's coffers (and your personal one).  But an entrepreneur must balance taking chips off the table with avoiding giving too much away too soon.  Working from the perspective of the long-term needs of the business is probably the best thing an entrepreneur can do to decide.  It's more important to gauge whether a financial partner can help grow the your business rather than whether or not you are getting a great price.  Even though the macro environment may change, a good business will always have a buyer.  But then again, if November rolls around and there's still money on the sidelines, they may just force the island vacation on you.