Minority Stakes – Read the Fine Print Middle Market Mergers and Acquisitions by Colonnade Advisors

This episode is an excellent continuation of our discussion in E023 about the pros and cons of partnering with a financial sponsor. When a company is considering an M&A transaction, there’s a range of alternatives. On one side of the spectrum, there’s selling 100% of the company and exiting. On the other side of the spectrum is no transaction at all (“stay the course”). 
In the middle are the options to sell various amounts of a company’s equity.
When considering raising capital, more often, we see our clients sell a majority stake, in which an investor buys more than 50% of the equity in the company. In some cases, we see a minority stake investment, which is less than 50% of the economics.
Today’s episode dives in deep on minority investments, and Colonnade Advisor’s Managing Directors Gina Cocking and Jeff Guylay explore:
Reasons companies take on minority investments Different types of minority investors and what they are seeking  How minority investments are valued What rights come with minority investments  The biggest challenges associated with a minority stakes investment  Advice for companies exploring minority stake investments  Reasons companies take on minority investments (1:56)
Gina: The most common reason we see is to buy out a minority partner. Another reason is to increase the equity capital in the business so it can raise debt and finance growth. Often, there’s a thin layer of equity in founder-owned companies because they’ve been distributing their own capital. They now want to make an acquisition, for instance. To make that acquisition, they will need more capital in the business. They need equity to then raise debt.
We hear business owners say, “I want to diversify my investments. Or, I would like to fund my kids’ education, weddings, etc.” Minority investments can be raised to give owners of businesses some liquidity.
Jeff: In our last podcast (E023), we talked about the value that financial sponsors bring to a founder-owned or an entrepreneurial-run company in terms of strategic benefits to the growth of the business. Sometimes we hear our clients say: “I don’t need a lot of growth capital” or “I don’t need a lot of liquidity” or “I don’t need to buy anybody out. But this might be the right time, given what’s going on in my industry, at this particular point in time, to bring on somebody who can help me out. I might need help in the capital markets. I might need help with a growth plan. I might need help with acquisitions.”
These strategic issues are important and sometimes supersede the economics of the transaction.
Different types of minority investors and what they are seeking  (4:58) Gina: I tend to put the investors into three buckets: venture capital firms, strategic investors, and private equity firms and family offices. 
Venture capital funds frequently make minority investments in companies. VCs are more focused on companies that are pre-profit and in the early stages with a lot of growth ahead. When you take an investment from a venture capital firm, you’re not getting liquidity. Dollars are not going into your pocket. 
Jeff: Venture capitalists are focused on putting capital into the business to help you grow. 
A strategic investor is interested in investing in a company to lock in a long-term relationship. If one of your vendors has an investment in you, you’re probably not going to move away from that vendor. So that’s where you can get strategic money.

Strategic investors will also invest in companies to watch new technologies as they grow. They are then at the forefront and in a position to make an acquisition later of that company.
Jeff: Strategic partners bring not just capital but relationships. They’re investing in you because there’s a good business case, and they’re going to help you grow. 
Gina: The third bucket is private equity firms and family offices. Some PE firms will make minority inv