In the title, we draw inspiration from the name of the renowned 1989 book “Barbarians at the Gate” on leveraged buyouts written by Byran Burrough and John Helyar. This narrative characterises financial buyers as modern-day raiders who are not armed with “real money.” However, contrary to the position in 1989, today the coffers of Private Equity firms (“PE”) have swelled, and in 2023 surpassed £1.9 trillion after a slow year in dealmaking, combined with limited opportunities for firms to deploy capital.
This means that your business may be a prime target for a Private Equity deal in a market that has become efficient and highly effective. Since 1989, the dynamics have significantly shifted – but what are the pros and cons of Private Equity, and should you sell to them?
The advantages of a Private Equity deal:
- With abundant capital to invest, Private Equity bidders can match many trade buyers in an auction process. Any retained shares that sellers may opt for bring motivation to accept a deal.
- Private Equity provides vendors with the opportunity to realise all or part of their business’s value, effectively reducing risk.
- Vendors can ’cash in’ most of their equity on completion but retain a stake in the future growth, a two-way bet-hedging on the future value of the business.
- Equity-backed firms can attract better talent and introduce sophisticated and effective strategies at the board level.
- A robust financial approach combined with challenging ideas can fuel growth and value. from the range of expertise that Private Equity firms bring to the table, including financial and international opportunities can drive the ‘scale-up’ of the business.
- Contrary to the ‘raider’ days, today Private Equity has access to substantial capital for growth initiatives and acquisitions, allowing businesses to scale up without the risks to the founders that often precluded such decisions.
- Founders and management can stay involved in delivering the business vision however, if a Private Equity buyer thinks there is no one capable of running the business as the sellers step back, it can lower the valuation and Private Equity appetite.
- Private Equity firms’ expertise in selling businesses enhances the potential value realisation on any later exits.
The Disadvantages of a Private Equity deal:
- Private Equity deals increase pressure on costs and cash management.
- Private Equity has access to the best external talent and can create turmoil among the ‘old guard’ In your management team.
- Some deals are too complex, and financiers, with their spreadsheets at the heart of many discussions, can make difficult bedfellows.
- It is common for many sellers to choose to step aside on completion, but for some, still holding an equity interest in the business but having a passive delegated role in the business they once owned can be a love-hate relationship.
- Many businesses do not have the growth profile to be attractive to Private Equity.
- Some Private Equity-backed deals can reduce in-house talent as the owners’ expertise can be driven from the board and the switch from ‘cultural to commercial’ can be too quick and result in lost value.
- A ‘good’ trade sale typically delivers a cleaner break than a Private Equity sale with more cash upfront and often an easier due diligence process than Private Equity with less focus on short-term financials.
Preparing for sale
Both trade and Private Equity suitors evaluate businesses based on similar metrics. An employee ownership sale may also be considered, making it crucial for corporate finance advisors to be involved early in the process to establish the best exit options and value drivers, identify pitfalls, and explore opportunities for sale preparation.
Identifying the right investors and buyers and negotiating terms constitutes only a small portion of the advisory process. Early advice can contribute to building long-term value, particularly as Private Equity buyers tend to dedicate more time to assessing forecasts and commercial due diligence than trade buyers. Therefore, being able to present up-to-date financials, metrics, and competitor analyse against your forecasts is crucial.
Additionally, understanding which customers consume time and incur costs, whilst developing effective strategies to expedite the decision-making process with them is essential, and highlighting the unique value proposition that sets your business apart is key. What makes you better, and why should investors and buyers choose your business?
The degree to which the business is driven by the sellers is a critical consideration. A management team that a buyer believes can successfully execute the business plan can instil confidence in Private Equity buyers and potentially enhance the overall value of the deal.
Most Private Equity deals involve acquiring 50% to 100% of the initial shares, with between 70 to 80% being paid as cash on completion. The remaining portion usually comprises a blend of earn-outs, deferred loan notes, and/or shares rolled over or retained in the business. It is crucial to protect any earn-out arrangements, with sellers typically maintaining a strong involvement in the business during this period. Additionally, thorough buyer diligence is essential where shares are being retained.
When evaluating a Private Equity deal, examining the Private Equity’s track record, particularly in terms of successful later exits, is vital. Conversations with other founders who have engaged with the same Private Equity firm can provide valuable insights for assessment.
Sellers, contemplating retaining stakes should exercise caution regarding the “equity illusion”. This arises when leveraged debt used for the buyout diminishes the value of any retained shares. Awareness of the potential impact of leveraged debt on retained equity and any seller protections regarding, for example, later dilution, is crucial to understanding the true value of retained shares over the longer term.
Private Equity valuation methods are the same as those employed in trade sales although more emphasis will be placed on cash flow as seasonality and normalised capital underpin the ability to leverage any debt. This sounds more complex than it is, and a good corporate adviser can guide you through these scenarios.
When to consider Private Equity
There is no one-size-fits-all template when it comes to selling a business. Each business owner has unique motivations, whether it is complete retirement, risk reduction, or seeking funds to fuel growth. In the emerging mid-market segment, encompassing businesses with profits ranging from £500,000 to £5 million, Private Equity buy-ins are geared towards scale-up growth and job creation. The goal for the Private Equity firm, perhaps in collaboration with initial sellers, is to realise substantial gains in productivity and value, ideally achieving a growth trajectory of three to four times the initial investment and realising this value within, say, five years.
While a ‘good’ trade deal leverages competition to drive up the price, engaging with Private Equity firms during the sales process broadens the auction process and provides sellers with reassurance on how a well-structured Private Equity deal might compare favourably. Discussing how a sale to Private Equity might impact company culture, management practices, and day-to-day operations is crucial before any deal is agreed upon. Ensuring alignment between the company’s vision and that of the Private Equity firm is essential, understanding how it may influence the future direction of the business.
With £1.9 trillion seeking investment opportunities, Private Equity firms today arguably exhibit a high level of motivation compared to many trade buyers. While the “Barbarians” may wield spreadsheets as both a sword and a shield, history has shown that civilisations have been regenerated by the “raiders” and it is exciting to examine Private Equity deals alongside trade, recognising the potential for transformative change and growth in both scenarios.
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