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Why Partner Fit Is Essential in Minority Transactions

  • Why minority transactions don’t provide as much control as a founder anticipates
  • Why partner fit is important under these circumstances
  • How founders can ensure they identify a good fit for their company

In a minority transaction, a founder retains majority ownership by selling less than 50% of their business.

While these transactions are common (98% of private equity firms make minority investments) and are intended to leave the founder in control, they do not preclude a founder from being selective about whom they choose to partner with. If anything, partner fit is even more important in a minority vs. a majority transaction.

Here’s why and what’s at stake.

Fit Is Especially Important in Minority Transactions

Partner fit is important in any investor relationship because the investor is going to influence the strategic direction of the business. But the importance of partner fit is different for minority vs. majority transactions.

In a majority transaction, the founder is essentially handing over the reins. They’ll still have some say in the business, but largely they want the new investor to take the lead while the founder goes along for the ride. In this case, a good fit is usually a partner who is willing and able to do the activities the founder wasn’t able to.

But when a founder sells a minority stake, it’s because they want to stay involved and maintain control. While holding a majority stake means the founder keeps their majority vote, most investors don’t provide capital without expecting a seat at the table—a literal seat on the board and the ability to share their opinions.

Consequently, it’s important that your visions and goals align. Even if investors don’t have majority control, they’ll still have a vote. Note only that, but in many key areas they’ll have a veto right or a controlling say in what happens.

For example, if you wanted to sell the business but an investor carried a veto/blocking/approval right on the sale, they would have full power to block it. The same goes for:

  • Budget
  • Hiring/ Firing
  • Which projects you invest in
  • To raise more capital or not
  • And more

In this way minority transactions are dangerous, because the perception is that you are in control when in reality you may not be. That’s why fit is so important. The last thing you want is an investor who isn’t aligned or disagrees about strategic direction.

Given the importance of finding a good fit, what can you do as a founder to ensure you’re talking to the right investors?

How to Run a Competitive Process to Find the Best Partner

The best way to find a good partner fit is to:

  1. Create a diverse buyer list
  2. Run a broad, competitive process

1. Create a diverse buyer list

While some founders are tempted to choose a fund based on reputation, it’s better to consider a variety of personas. Be open to all types of investors and buyers. Some founders have a better outcome with a different persona than what they had initially expected. Having more transaction options will provide the best opportunity for your company in the long term.

Below are some important considerations when evaluating an investment partner:

  • Have they been founder-friendly?
  • How many board seats do they want?
  • What is their typical holding period?
  • What veto rights and exit options do they want?
  • Do they take a passive or hands-on approach?
  • How have they helped grow other businesses?
  • Will they bring along other resources?
  • What do their return profiles look like?
  • How frequently do they replace management?
  • What kind of returns are they looking for?

2. Run a broad, competitive process

When you have different investors all vying to invest in your business, you can negotiate towards your ideal outcome in terms of fit and economics. To foster competition between investors, you should strategically share data and structure the process according to a strict timeline. As you do so, you’ll be able to tease out the characteristics of investors that you feel best fit your objectives and then nurture relationships with those that meet your criteria.

For a founder who has limited experience raising capital from institutional investors, running this caliber of process without help will be challenging if not impossible. Consequently, it’s important to enlist a good investment bank before engaging with potential investors.

How an Investment Bank Can Help

The right bank can run a competitive process that will get you the best possible outcome—a key piece of which is finding the right fit.

One of the primary ways a bank helps is by knowing the market and the different investor personas. The bank will already be familiar with the investors and will have insights into how they operate. They have seen how the firms interact during a transaction, as well as a year or more afterwards. As a result, they are in a great position to help you identify buyers that best meet your criteria.

Moreover, a bank can help you demonstrate that you’re a good fit for the right investor. First impressions are important, and a bank will help properly position your message for the market and ensure you don’t disclose too little or too much. They can also help find out as much as possible about investor expectations early in the negotiation process.

Other ways a bank can help

For one, a bank can help you leverage exclusivity to gain value—meaning they won’t sign a letter of intent granting exclusivity until they’ve agreed on the value and the terms of who will control what. That timing is important because once you enter the exclusivity period, you can’t negotiate with anybody else and thereby lose a lot of your edge.

Investment banks will also carry the burden of managing the process and handling any hard conversations with investors so that you maintain a positive relationship with your partners.

Embracing Options and Competition

The best partnerships start by ensuring that your visions align so everyone has the best chance of getting what they want. Work with an investment bank to make your search is as competitive as possible to help you make the best deal. You’ve put a lot into your business, so it’s worth it to find a partner that’s the right fit.

Learn more about running a competitive process and the investor personas you’re likely to encounter.

The views expressed here are my own.

Modified on Jul 12, 2022