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Published: January 10, 2023
Updated: January 10, 2023
A private equity (PE) deal could be a catalyst for growth and innovation for your business or a strategy that will allow you to exit on your own terms. However, to ensure a successful outcome, it's important to have your financial reporting and internal controls in good shape for due diligence by the PE investor pre-acquisition and for ongoing operations post-acquisition.
With the rise of PE investment in small and mid-market businesses, companies need to be prepared should they be approached. To have a strong foundation for a future transaction, your company needs to start preparing early. This will give you time to both identify problem areas and to address them.
In this article, we highlight the benefits of PE investment and how your financial reporting can influence investment.
Private capital is where the growth is
Private capital is the broader term used for investment in assets not available on public markets. This encompasses PE, venture capital, private debt, and real estate.
The private markets are becoming a much bigger part of the overall Canadian economy. In 2012 private capital investment was only 6% of the economy. By 2021 it rose to 12%.
Additionally, private capital is increasingly investing in small and mid-market companies. In 2021, 26% of investments were in small-medium businesses (SMBs) and mid-market enterprises and that's forecasted to rise to almost half at 42% by 2026.
Source: Statistics Canada, forecasts modelled by BDO
There are a few reasons for this growth. Firstly, the benefits of remaining a private company are plentiful, including avoiding the cost of an initial public offering, maintaining more control of the company, and having more flexibility to think long-term rather than focus on short-term or quarterly results. Secondly, the significant volatility we're seeing in the public markets makes it difficult for companies to raise money when markets are down.
“Although you may not be thinking about PE investment right now, the probability of being approached by private equity increases as this trend grows,” said Mary Mathews, Partner, Accounting Advisory Services at BDO. “It's important for SMBs and mid-market enterprises to consider preparing now,” she added.
How the mid-market benefits from private equity investment
The financial and operating expertise that a private equity firm can provide are part of what draws many owners to this path as an exit. PE partners can create a high level of operational efficiency and provide resources for rapid expansion. For example, PE firms can provide:
Preparing your financials for private equity investment
Although PE firms have a significant amount of capital and are willing to invest in promising assets, they set a high bar before making an investment—even more so during an economic downturn (read four tips for raising funds during an economic downturn here). Their due diligence is a time-consuming and complex process. PE firms will look to get a deep understanding of a business' financials, management team, technology stack, as well as its strategic direction.
Therefore, it's important to be ready and develop solid financial processes and internal controls before a PE firm approaches you. This will help them determine whether or not they want to invest, and at what price.
What your business needs to consider before entering negotiations:
- Get your financials audited to give credibility to the figures you present to investors.
- Consider the accounting standards you use. You may want to change them depending on your goals, especially if attracting U.S. equity investors is one of those goals. Learn more about choosing the right accounting standards here.
- Clean up your capital structure. If you have a capital structure that is too complex, (for example: multiple classes of shares etc.) then it may be difficult to bring in the right investors.
- Ensure you have good internal controls and systems to help attract investors, make deals go easier, and reduce headaches on both sides.
- If you can't produce timely and accurate information for investors as they perform their due diligence, you'll create uncertainty. That uncertainty could be reflected in the purchase price—or result in a re-negotiated price.
Strong forecasting capabilities provide investors with a clear picture of where the company is going. It also shows that you understand the total available market for your product and the cost of running your business.
- Investors want to look at all aspects of a company's performance and how it will fit into their portfolio. PE firms are increasingly interested in potential value (or potential risks) created by environmental, social, and governance (ESG) factors.
- A firm may subscribe a discount to reflect the lack of ESG risk management or they may actively avoid assets with poor ESG standards. Learn more about ESG reporting here.
- It's important to work with the right professionals—such as lawyers, tax, and financial advisors—to help manage and execute all of the documentation and data requests outlined above.
- Consider undertaking a sell-side due diligence process ahead of negotiations to identify areas where your reporting may be lacking and to mitigate any issues and improve outcomes.
- BDO experts use an integrated approach to help businesses adapt or improve their financial processes to be fully prepared when a PE firm knocks on the door.
When companies don't properly prepare, transactions get delayed, deals die, or it impacts the price they receive.
“Choosing not to invest in financial reporting or a sell-side due diligence process could increase the due diligence the PE firm performs and potentially increase the risk associated with the acquisition,” said Sunil Sharma, National Leader, Transaction Services and Private Equity at BDO. “Any purchaser will embed that into the price they are going to pay. The more issues they find in diligence, the more the price will deteriorate,” he added.
BDOs team of experts will work with you every step of the way, making sure that when potential investors come knocking, you'll be ready. Our Accounting Advisory and Transaction Services teams provide comprehensive support to achieve better acquisition results.