For investors who want to increase their exposure to private investments, and the outside returns they can produce, minority investments (taking less than a 50% share in a private company) can represent an attractive opportunity. Minority investments, relative to traditional control buyouts, can help investors mitigate risk while preserving the important alignment with existing shareholders and management to grow the enterprise.
With minority investments, existing management teams typically stay with the business and retain significant ownership interest, which aligns the management team with the investor and helps to ensure continuity of the business’ strategic direction.
In addition, minority transactions are often executed through a preferred security that can include a simple liquidation preference of 1.0x+ for investors. These types of transactions/partnerships typically use less leverage than leveraged buyouts, which can decrease risk to the investor.
In today’s volatile market environment, minority investments can be particularly attractive. Consider this: valuations in traditional buyouts multiples have declined in 2022, while at the same time interest rates are rising.
In addition, M&A volume has slowed in 2022 as private business owners saw their valuations hit a peak in 2021. Because of the downward pressure on valuations, businesses that previously considered a private equity acquisition (i.e. full exit) may now be interested in seeking minority recaps and other partial liquidity events. This presents a promising opportunity for investors. Below are just some of the benefits that minority investments can provide:
Why Minority Investments Make Sense for Investors
- Access to durable and scaled companies with entrenched management teams at reasonable entry valuations.
- Better risk-adjusted return opportunities in the form of liquidation preferences, earn-outs, seller notes, etc.
- Middle-market transactions typically have large exit landscapes, as investors can achieve returns without IPOs or “headline” exits.
- Typical protective provisions and rights include the ability to appoint directors and vote at board meetings, tag-along rights, right of first refusal, pre-emptive rights, veto rights on certain fundamental matters, and more.
- There is usually less buy-side competition for minority equity transactions versus traditional buyouts in mature, profitable (recession resilient) businesses.
For business owners and entrepreneurs, minority investments also present an attractive opportunity to infuse cash into a business, and take some personal liquidity, while maintaining a say in the future direction of the business:
Why Minority Investments Make Sense for Entrepreneurs and Business Owners
- Minority transactions enable entrepreneurs and business owners to:
- Further capitalize their businesses for organic and inorganic growth
- Take partial liquidity to bolster their personal balance sheets
- Maintain control / ownership for a future exit (typically in 5-10 years)
- Both the management and investors have significant economic interest in the growth of the business and can pool resources for strategic opportunities. Plus, minority investments can be less disruptive to the management and culture of a business.
- Investor groups can enhance a company’s board through operational expertise, industry knowledge, and a strong network, which can inject new ideas and growth into a business.
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