In the previous lesson, we said that when we talk about private equity we always have considered two different aspects, a story of financing and a story of equity investing. In this lesson, we have to focus our attention on the financing story. That basically means why does a company use a private equity to satisfy the need of money? That's quite important because to accept a private equity on board for a company it’s a very tough decision because it's not like a story of a bank giving loans, where simply the bank just gives money to the company but basically the bank remains an outsider. The private equity becomes an insider of the company, and the company has to negotiate this “marriage” as we mentioned before. Typically both academia and practitioners really love to say that a company accepts a private equity on board for four very relevant benefits. The four benefits are: the certification benefit, the networking benefit, the knowledge benefit, and the financial benefit. Let's start with the certification benefit. If you accept to have a private equity investor on board, you are, in a certain sense, certified, because the decision that the private equity took to invest in a company means that the company is a company of very high quality. For this reason the company can use this stamp to promote its qualities, profiles, and reputation all around the market. For example, if you want to penetrate a new market and you don't know anything about this market, your brand name is completely unknown, you can demonstrate that you have a very high reputation because the private equity investor decided to invest. And you promote the brand of your company. The second benefit is the so-called networking benefit. Every time the private equity investor invests in a company, the private equity gives a strong support to the company giving an access to his or her network; which means to multiplying opportunities and interacting with new suppliers and with new customers. That's absolutely important for a company willing for example to grow the amount of sale. The third benefit is the so called knowledge benefit. As the private equity investor becomes a shareholder of the company, the private equity is able to transfer his or her knowledge to the company. Knowledge could be soft knowledge: Soft knowledge means capabilities to manage a team, capabilities to lead a company, capabilities to negotiate with other players; but knowledge could be something harder. For example, industrial knowledge, expertise in chemicals, and in R&D. So knowledge is quite relevant, especially for companies that are in the very first phase of development, that means in venture capital deals. The last benefit is the so-called financial benefit. Just simply for the reason a private equity invests in a company, the company receives an incredible support. And support is made by the increase of the amount of equity and is made by increase of the credit standing of the company. That means the rating of the company is going to increase, and as the rating of the company is going to increase, the capability of the company to reduce the cost of capital becomes absolutely affected. So, four benefits, all together, that the company can buy every time the company accepts to have a private equity investor on board. Let's come back to the main reason why a company needs a private equity investor: for money. But the reasons why a company needs money are not always the same, but it depends on the stage of the life cycle of the company. So using the very simple concept of life cycle we can see that the reasons why the company needs money are completely different. In the first phase which is named development, the company needs money to sustain R&D activity. That means to create a business idea. In the startup stage, the company needs money to buy fixed assets and to finance working capital. In the third step, which is the early growth, the company needs more money to sustain the first phase of growth. In the expansion, when sales are flying, the company needs money because the company needs to buy new fixed assets and needs to finance a working capital because of the growth of the sale. In mature age, probably a company could need money to launch an acquisition to run new fixed assets, or to completely transform the business. And in the last phase which is very sad, which is the decline, the company needs money because it has to try to exit from the crisis. So six different stages: six different reasons why the company could use the private equity investor. But, the private equity investor is not the only solution to the need of money. In every stage there is, in a certain sense, a competition between different players able to give money to the company. If we come back to the concept of development, where the entrepreneur needs support and money to design the business idea, probably banks are not able to give money. But typically, financiers are represented by family and friends, by the founder, by the business angel, and by private equity investors, that we name in this case venture capital. In startups where, again, the risk is very high, business angel, venture capital investor, family and friends, are the major financiers of the company. It's very hard that the banking system is able to give money. If we move to early growth, in this case venture capital is absolutely fundamental, but as sales are starting, the banking system is also able to provide money. If we move towards expansion, in this case banking systems and trade credit are probably the major sources of financing, but also private equity could be relevant. If we get to the mature age in this case, a company can use a very wide portfolio of alternatives. As the company's adult, the company can use the stock exchange, it can run and IPO, it can use a private equity investor, and it can obviously use the banking system as well. And in the last phase which is the phase of decline, it again, becomes very difficult very difficult to have the banking system on board. In a certain sense, the decline is very similar to a story of development of a startup. In this case, we have to come back to the portfolio of the founder, to family and friends and to private equity, to finance the company again.
