In early May, environmental consultancy SLR Holdings announced that 3i would be investing £32.5m for a significant minority stake in the business, replacing ISIS Equity Partners. The investment is just one of a long line of minority stakes taken by 3i Growth Capital, which has invested more than €2.5bn from offices across Europe, Asia and North America in the past five years. Those investee companies have achieved average annualised growth of over 30% and profit growth of 17.5% in the last three years, says the firm.
Today’s tighter credit market could make taking minority stakes more attractive for a larger number of PE houses. There is also potentially higher demand from companies that are seeking new capital but discouraged from a public listing because of uncertain stock market conditions. “Having a private equity investor that is able to bring sector expertise, geographic reach and industry contacts to a company with significant growth aspirations can be more beneficial than a stock market listing at a time when there is uncertainty and volatility in the financial markets,” says Simon Tilley, a managing director at Close Brothers Corporate Finance.
He adds that he has seen several situations in recent months in which a company has put plans for a stock market listing on hold. While a listing is attractive in terms of bringing a partial exit for management or original investors, the bigger prize is having a strategic and financial investor on board to drive the company’s growth ahead of an exit when market conditions are more favourable.
Firms such as 3i, TA Associates and Summit Partners have a long track record on minority investments, while others such as ICG, Bank of Scotland Integrated Finance (BoSIF) and Indigo are more recent entrants and have developed a model more suited to mature businesses and later stage investments, says Tilley. But he warns that any PE houses without experience of minority investments will need to think carefully about control issues.
Iain Kennedy, a partner at Duke Street Capital, which does not take minority stakes, agrees that control issues are crucial. “You need to ask yourself what happens if things go wrong,” he says. For Duke Street it is important to be able to change management, if necessary, and to decide exit issues, notably the timing, the value and who to sell to. Kenney says: “These two issues are crucial because the reason most companies underperform is poor management and the way the exit is handled is the most important influence on whatever gain you’re going to make.”
A key issue in minority stakes is what happens if things go wrong with the business. In the integrated financing model of BoSIF, for example, the investing firm is able to use preferred instruments to effectively take control, says Kennedy. But generally he is sceptical of the value of minority stakes. “What’s the point if you have no voting rights or control to decide what happens? It may be possible to ensure some legal protection if things go wrong, but I think you’ll always struggle to add value through buy-and-build or a transformation strategy if you have a minority stake.”
But those with longer experience of minority stakes are convinced of the advantages, while arguing that it is a specialist approach that is not necessarily appropriate for most PE houses. Dave Whileman, a partner at 3i Growth Capital, says the firm takes an active partnership approach to the businesses it invests in and that investments are at an earlier stage than traditional private equity. This approach is focused on high-growth companies and there is lower leverage than in traditional PE, he says.
Whileman acknowledges that being a minority shareholder means 3i does not have control of the business. But being extremely careful about which companies and management teams to invest in minimises potential problems, he argues: “We’re able to add value to the business beyond that of just capital and this quickly builds trust and influence regardless of whether you have a controlling stake.”
Whileman says he expects other PE houses to want to emulate 3i’s success: “However, the essence of these transactions is around entrepreneurs seeking a partner not a new owner. In our experience these are discerning individuals who are rigorous in satisfying themselves over the personality, style and expertise of the investor joining their board and the impact their international and sector networks can bring to the business. It takes time and resources to build such a presence and track record.”