Private Equity (PE) is a form of private business ownership. Many large businesses are PE owned and they are distinct from listed PLCs where shares are publicly traded. PE firms will manage funds for groups of investors who are seeking a return on investment either in the form of income or capital (or in some cases both). PE firms can take majority ownership, a minority stake or outright ownership of the business and typically will hold their interest for a period of 5 to 10 years before seeking to exit their investment usually via a secondary buy out (by another PE firm), a trade sale to a competitor or a flotation on a listed stock exchange.
How is it Relevant to our Business?
High growth businesses (particularly those seeking additional growth capital) and owner managed businesses in a fragmented market are of particular interest to PE firms. Additionally, PE can facilitate a succession event such as a management buyout by providing all or a proportion of the funding necessary to buy out founder shareholders.
What Types of Businesses Does PE Invest in?
PE funds primarily seek a return on capital for their investors so early-stage high growth companies are an obvious attraction. Owners of high growth businesses may be willing to give up a proportion of the equity in the business in return for investment which should, all being well, lead to an increase in the overall value of the business for all stakeholders.
Alternatively, stable but profitable owner managed business within a well-established or high growth fragmented market are often of interest to PE firms pursuing a buy and build strategy within a particular sector. In this example a PE firm will typically identify and acquire an established business usually with a highly motivated founder or management team who are then tasked with buying additional businesses in the same sector to quickly scale up. The key attraction here for the PE firm is that the multiple used to value the business tends to grow as the business scales up. The theory, often referred to as “arbitrage”, is that if the PE fund can acquire a small OMB at a multiple of say 8 and then sell it on as part of an enlarged business based on a higher multiple then it has instantly made a profit and achieved a return on capital.
What is a PE deal likely to look like ?
There are no set rules on how PE deals should be structured but for the purposes of this article we will focus on a sale of an owner managed business to a PE backed acquirer. In this example an offer will be made for 100% ownership of the business based on an enterprise value (EV) which is often based on a multiple of the company’s recent earnings. The offer made for the shares will be based on the EV adjusted on a cash free debt free basis (this simply means that the EV is adjusted to recognise existing cash and debt in the business together with its working capital requirements.
A key feature of a PE deal is that founders are often asked to “roll over” a proportion of the sale value into the acquisition vehicle being used by the PE fund. This is usually done by exchanging a proportion of shares in the business for new shares or loan notes in the buyer or by investing part of the sale proceeds directly into the buyer in return for shares or loan notes. Whilst the core sale will follow a typical M&A transaction the “roll over” element requires careful attention as the value of the founder’s investment will be directly impacted by a number of factors including the rights attaching to the shares or loan notes, the timescale in which that investment is likely to be realised (usually when the PE firm decides to exit its investment) and the leaver terms should a founder wish to leave the business. We have extensive experience advising business owners on PE backed transactions and early advice is key in order to achieve the best outcome for you and your business.
If this is something you need further assistance on, please contact our Corporate and Commercial team.