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Private Equity Financing Selection Criteria for Startups

Here's a peek into how PE firms pick the companies they work with.

Global Influencer

Global Influencer
Global Influencer

I’m a partner with Equifaira Advisors in Vancouver. Equifaira is a company that does liquidity event planning. We are specialists in strategy & execution, corporate finance, capital formation & investor relations.

Our vision is “We open the door to private investing wealth for everyday people.”

A lofty goal for any company but certainly attainable. To that end we are very selective with whom we work and see our selection criteria as the only way to weed out companies we may regret down the road as well as providing sound choices and opportunities for possible investors.

I’ve seen consulting firms take on clients after a brief coffee meeting to the detriment of everyone. Our process often takes several weeks to months and the criteria are defined and the company we are considering as a client is overseen by a standing committee of four senior partners.

Special thanks to our partner, Norris Phillippe, for developing the basis for the selection criteria itself. Of course, selecting criteria is not rocket science but to the degree we analyze and work is intensive and extensive.

The pre-assessment selection criteria are broken into nine steps.

1. Founders and Key Personnel

If you must work with people it better be one of mutual respect coupled with knowledge of how they will work with us as a team. Remember the client will most likely be with us until a liquidity event that in most cases will take a minimum of three years and maybe longer.

We look for strong leaders with a good working relationship with the senior staff, have that spark we all like to see in entrepreneurs and has passion for coming to work and innovating every day.

We work with Founders who have a strong background and expertise in the company they have founded.

An unusual aspect of our business is that we embed one of our partners into the client’s company in a position that will enhance the operation and assist it to grow. Obviously, it is important that a good working relationship would ensue and personalities are taken into consideration when embedding the executive. We ensure that what we provide in personnel is a value-add to the start-up.

2. Product or Service

We don’t have many clients on our roster at any one time for a reason; we want innovative often disruptive technologies that will make a difference in the market. It needs to fill a need that is remarkable with a product or service that is a game changer. We know, from past experience, if the right chemistry is there we can take the company to the next level.

We look for a consumer or a commercial product that has a local, national or global marketability.

3. Stage of Business Development

We look at whether the business is pre-revenue or in revenue. Depending on the company often revenue generation is required for our involvement. We determine whether there is a need for further product development and how the start-up will get to the next stage. We also calculate how long it will take the company to get to market assuming it is still in the development stage.

We have clients in each stage from pre-revenue, through early growth and maturity right up to clients in the liquidity event scenario.

4. The Funding Profile

We start off with an assessment to see whether it is actually feasible to raise money for the company. Looking at the equity model for potential growth we create a spreadsheet of what the shareholders will look like over the next five years. Having done this we can then develop a valuation of the company and determine the share price of the offering. We also look at whether their share structure now and in the future can support their financing plans.

We look to see if the start-up fits our model of slowly building up financing while making sure the founders keep as much equity as possible. Typically if the company wants one or two very large investors it won’t fit our structured approach to financing. If the company has no history of raising capital we like to start with a family and friends round leading up to more robust financing options. It’s like working on a progressively growing circle of influence.

Our goal in the end is to increase the number of shareholders, increase the price of the shares and keep the founder’s equity high.

The last part of the funding profile is we look at the regulations in the jurisdiction to see what restriction we may have while guiding the company to raise capital.

5. Current Capitalization

We look at the shareholder profile of the company as a selection criterion. Are the outstanding shares common or preferred? Are the shares closely held by family and friends or are they widely distributed?

What is the book value sum of the company’s stock, long-term debt and retained earnings? With an analysis of the share structure we can determine the market value of the company and determine how much the company can afford to raise. It is rare but sometimes we run across a company that is overcapitalized meaning they have enough profits to support growth and really don’t need to raise money.

After an assessment we need to be assured that the company’s share structure has the capacity to raise more money while still allowing the founder to maintain his equity.

As part of our model we like to be able to invest in the company ourselves. Besides embedding an executive into the management we like to show our faith in the business through ownership.

6. Acceptability of Equifaira’s Approach

Obviously, to be part of the team and to do our best work we must have 100% support from the founders and senior management. It’s absolutely essential that everyone is on ‘the same page’ with our guidance and that the determination is reached by consensus. It’s really easy to see the commitment level from all parties through our assessment that also includes support from the board and their advisors.

7. Legal

You knew this had to be a part of the assessment process. Does the company have intellectual properties and have they been protected by trademark, patents and copyrights? Does the company have any issues that may create problems now or down the road and are there any issues that are pending?

8. Due Diligence Checklist

With our involvement in a company comes the responsibility of making sure that brokers, investors and other interested parties are protected. Our investigation works to disclose as much information about the company, its officers and employees to be able to reassure people that the company is a safe place to invest.

We look at everything from founders, staff, the revenue, the competition and the industry. We study their business model to look for gaps, their management for the right level of expertise and look for big changes that have happened from their inception.

We take into account the share structure and who has what in the company. Are there vested shares? Who retains control and how secure is that control? Are there a lot of stock options out there from contractors, consultants and employees and what are the dilution possibilities?

We look at the top line balance sheet for all of the company’s assets and liabilities as well as the last audit.

What is the company’s exit strategy and does it fall into our expectations? Is the company’s overall strategic plan in alignment with ours?

What are any risks and undisclosed issues? We were looking at a prospective client who had a major problem with a couple of former employees. The employees on the development team were claiming they owned parts of the patent. Issues like that can derail our involvement.

We then identify whether the flaws, if any, that we found are both acceptable and fixable. The final part of our assessment is a breakdown of everything into a SWOT analysis.

9. Approval or Decline

Since Equifaira is putting considerable resources into the company over a usually extended period of time we need to conclude our assessment with a strong approval or decline. We are in the enviable position that there are more clients in the market than we need or can handle so our assessment is unbiased and fair. We clearly identify any and all issues to the prospective client and, in some cases; offer to revisit them at a later stage in their business development.

The astronomer Carl Sagan said, “It was easy to predict mass car ownership but hard to predict Walmart.”