Lesson #149: Can't Attract Venture Capital? Buy a Business with Private Equity!

As we have discussed in the past, venture capital investors are looking for different things than private equity investors.  Venture capital firms are typically growth-oriented, early-stage investors.  And, private equity firms are typically cash-flow oriented, later-stage investors, looking to invest in companies in excess of $10MM in revenues and $3MM in EBITDA in size.  So, as an early-stage startup, why on earth should you consider reaching out to private equity investors, if you are not making progress with venture capital investors?  Because you are going to pitch them with an entirely different growth strategy altogether.

Instead of pitching a brand new startup, like you did with the venture capitalists.  You are going to pitch them on the acquisition of an established business, or a roll-up of established businesses, in your space, that will collectively get you the revenue and EBITDA size they will require.  Then, you pitch them to put you in charge of the business post funding, responsible for the execution therefrom with your new-generation solution. 

You won't walk away with 75% ownership, as you could with a venture financing in your early-stage startup.  But, you could walk away with 10% ownership (a reasonable stake for a non-founding CEO in a PE backed company).  So, economically, it could be the same to you, if not better.  As an example, owning 75% of a $4MM startup business is the same as owning 10% of a $30MM established business (with a lot less risk given the established client base and revenue stream).

As a case study, I have a client that has a "game-changing" technology in their industry, with a real potential of building a $1BN revenue business, as a next generation business.  But, if they were going to take their time, and raise venture capital for a startup, and slowly build to $1BN, it could take up to 10 years and other competitors could catch up or the entrenched old-generation businesses could build new-generation solutions of their own. 

But, instead of going down the slow road, where the venture guys were confused by the space with a glut of look-alike startups being launched.  Make a pivot, and pitch the billion-dollar idea to private equity firms, who could fund the acquisition of a big established, old-generation company, to sprinkle your magic, new-generation expertise and technology on their existing clients over night.  In this route, there is no need to build out a big sales team and establish new relationships, since they already exist.  By piggy-backing on existing sales relationships, you will get your product to market materially faster, potentially turning you into a $1BN business over night.

Now, I made this sound really easy.  In reality, there are a lot of complexities in this private-equity focused route.  Private equity investors will ask questions like: (i) does this entrepreneur really have the skillsets of running a big company (you may or may not, depending on your resume); (ii) who is the target company you are going to buy, have you initiated conversations with them and what purchase price will it require (suggesting you need to do your research and "shopping" upfront, to have a known target and go-to-market strategy in mind before you approach the private equity investors); and (iii) lots of things can go wrong with acquisitions, that will negatively impact sales (so what is your transition plan, and have you conservatively forecasted revenues post transaction).

The point here is not to be too myopic in your thinking about your business and growth strategies. There are more than one road to your end goal, of building the largest business in your space.   And, raising private equity, can often be a lot easier than raising venture capital, especially for recurring revenue businesses.  So, if you take the time to see the forest through the trees, interesting growth opportunities will present themselves.

If you decide to go down this route, here is a list of private equity firms in Chicago to research, as potential funders of your transaction.

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