For management teams looking to take control of their businesses with the support of private equity backers, debt has an integral role to play in funding buyouts.
Here are the top ten considerations that directors need to keep in mind when positioning a company to secure the necessary finance to complete a deal.
Having a unique proposition will attract private equity interest and the debt to support a buyout. Management teams will not only effectively need to articulate their position in the market, but also provide the confidence that their business model is defensible, with sufficient barriers to entry for new competitors. Fully protecting key intellectual property is an important step in securing your industry position.
2. Growth strategy
A clearly defined growth strategy, whether it’s organic or acquisitive, is at the heart of any investment proposal. Nevertheless, private equity investors and banks will want to see the future of the business mapped out. Pointing out strong market growth dynamics and emerging opportunities, as well as potential challenges, will help to attract the right interest.
Private equity backs management teams, not just businesses, so it’s paramount that management can demonstrate a solid track record of achieving organic growth, a broad skill-set, technical expertise and in-depth knowledge of their given industry.
Lenders place great emphasis on relationships and work with businesses that promote clear and open lines of communication. These close ties enable lenders to act appropriately and provide additional support if required. Taking a long-term approach, as well as being transparent and enthusiastic, will help to nurture a successful partnership.
Like private equity investors, lenders are keen to see management teams demonstrate that they are committed to the business and to help deliver its growth plans. By taking an equity stake, it’s clear that a management team is in it for the long-haul. If an influential director is keen to realise their entire stake, it doesn’t fill a bank with confidence.
Pricing expectations between businesses and investors have realigned in recent years due to the changing economic landscape. Management teams need to give a valuation that ensures they retain an incentive to push forward with growth. Be aware, however, that investors need a large enough slice in a big enough cake to receive an acceptable rate of return on exit.
Since the financial crisis, one of the main complaints in the deal-making community has been that transactions are taking longer to “get over the line”. Staying patient and professional is important as longer transaction timelines are now the norm. Make sure that quality advisors are in place to lead you through the process and can make sure that you get in front of the most appropriate private equity houses and banking partners.
7. Due diligence
To speed up the process, businesses must be prepared for a thorough due diligence process, which will ask serious questions regarding their financial and operational state and forecasts. They would also have to work with advisors to prepare all the relevant information and documents in advance. It is common place for due diligence to be carried out on management teams to make sure that their personalities are compatible with each other and investors.
As part of the due diligence process, banks are interested in businesses’s ability to manage cash-flow effectively while showing stability. With a veil of uncertainty hanging over the economy as it balances precariously between recession and recovery, there is a good chance that businesses will be confronted with serious challenges in the near future. Without a history of robust cash-flows, companies will struggle to convince banks that it can meet its debt obligations when the going gets tough.
Investors are looking for a stable business that won’t spring up any surprises. In particular, firms must ensure that they have a broad supply chain without relying on any single provider. Hedging against increases in supplier costs will also help to reduce apparent risks.
Private equity investors and lenders are keen to see recurring revenues within businesses. It’s important that they come from a diversified client base with long term stable contacts, so that obvious business risks are mitigated. A firm cannot be over reliant on one large contract. Be prepared for the due diligence process to look into customer/client relationships and request references on your performance.
Ian Sale is managing director of the Acquisition Finance team at Lloyds Bank.
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