Private Equity Demystified
The fundamentals of private equity deal structuring
"Private equity in many scenarios can be a win-win for both the founder and the management team, enabling the business to grow with the support of experienced investors and generating significant financial uplift for all shareholders on the ultimate exit." Anya Cummins, Partner, Head of M&A
Private equity (“PE”) funds are institutional funds targeting investment in privately owned businesses. The nature, size and structure of the investment can vary significantly but generally PE funds are seeking to provide growth capital or support buyouts unlisted entities with a view to securing strong returns on behalf of their investors over a pre-determined lifetime.
Top tips for a successful private equity transaction
- Be well prepared – if considering a PE transaction vendor due diligence is highly recommended. The level of DD undertaken by a PE fund, in particular on the business plan, the forecasts and quality of earnings is significant and the business needs to be prepared
- Understand potential red flags and address them in advance of a deal - it’s much better to be aware of and address where possible potential deal issues in advance of a transaction rather than an investor identifying major deal issues during due diligence
- A comprehensive business plan – a private equity backer is investing in the future growth of a business. Prepare a business plan backed up by a financial model with growth rates that support private equity target returns and leverage structures. The management team must believe the plan and assumptions need to be reasonable
- Align the objectives of the management team and the shareholders – there are natural conflicts in any transaction, and in particular in PE deal structures with buying and selling shareholders. Understand the objectives of all of the key stakeholders and agree the level of rollover and involvement in the business post transaction upfront (i.e. who is exiting, what stake is everyone selling, who is reinvesting and to what level? Etc.) This makes the level of the equity available for sale to the PE investor clear from the outset which may be a combination of growth capital in and cash extraction
- What are you looking for in an investor? – Agree your objectives and what you are looking for in a private equity investor e.g. access to new markets, expertise in supporting buy-and-build strategies, an ability to provide follow on funding, strength of Board appointments, etc. The approach, strengths and focus areas vary from fund to fund. Considering what you are looking for in your investment partner and identifying the right funds for you will help make sure you find a fit that’s right for your business
- Capacity of the management team – one of the main reasons deals fail is the management team becomes distracted with the deal process and all it entails, and the underlying trading performance of the business suffers. Ensure the finance function has the capacity for a transaction; and prepare in advance. Structure the deal team such that management have the bandwidth to also run the business. Consider the sale process timetable in light of peaks and troughs in trading in the business
- Debt funding – there are a number of ways in which the Vendor can take control of the debt process, including soft stapling or stapling of the debt. This helps ensure that the private equity bidders are basing their valuation on comparable assumptions that work for the business; and that the debt process (to the extent applicable) does not become a barrier to the completion of the transaction
- Knowing the market – often the terms of PE deals will be dictated to a large extent by what is seen as standard market practice for these types of transactions. Any attempt to deviate from perceived market practice will require a strong objective justification before it will be accepted by a PE fund (if at all)
For a founder and the management team, the ability to articulate well considered exit options at the point of entering discussions with a PE fund is a key positive.
Anya Cummins, Partner, Head of M&A