They say behind every successful entrepreneur you’ll find the investor(s) who helped them get there. From initial seed capital right the way up to institutional funds when a company floats, the investor is a key component to achieving success. However not all investors are the same. How do you choose the right one for you?
Here, we look at the questions business owners and management teams need to ask a prospective private equity backer.
Perceptions of private equity range from the much-maligned tag of asset strippers to intelligent equity partners. However, what is true in any case, is that careful attention must be paid before closing a deal to avoid finding out the relationship is fractured afterwards.
To shed some light on this, our sister title Real Deals brought together private equity investors, business leaders, corporate finance advisors and professional services specialists at a breakfast supported by private equity firm ECI Partners (ECI).
Colin Tenwick, chairman at ATG Media and Addison Lee, and Richard Prosser, chairman at Tusker and Audley Travel, know what it is like to be at the helm of businesses backed by private equity – as well as being part of companies growing in the private and listed spaces.
For Tenwick, he believes the competitiveness of the private equity market is bringing about greater differentiation, meaning management teams are “bamboozled” less and are now “spoilt for choice”. Tenwick’s career has taken him through positions at Bookatable and ControlCircle to his current non-executive chairmanships of online auction site operator ATG Media and private hire firm Addison Lee.
London-based Addison Lee took on backing from global private equity firm Carlyle Group in April 2013, with plans to grow the firm both domestically and internationally. He believes that identifying a private equity investor that has a sound understanding of the appropriate sector is very important.
“If you are making an assessment of an investor, you want to see an investor who understands the sector lexicon and has that the knowledge to drill down into the key areas and have a discussion,” he explained.
“From an investor’s perspective it is important too because you want to understand what is going on in that sector so that you have the confidence to move at pace and take some risks on the chin. You can only do that if you understand a sector, otherwise you are flying blind.”
For Prosser, chairman at salary sacrifice car provider Tusker and travel company Audley Travel, private equity firms need to be doing as much if not more of the differentiation that gets suggested to portfolio companies. “If you look at the market, you will see a lot of the houses tend to blur a bit,” he said. “But I think that in the current market, where there is competition and houses have to pay up for deals, then the more differentiation you can have as a house the better. Some houses are good at that, and have strong differentiators, and others don’t. It surprises me that firms won’t look at themselves in the same light as they would a portfolio company they would invest in.”
That sector expertise requirement was echoed by Mick McDonagh of Liberty Corporate Finance. However, he warned: “The only line you can’t cross as a specialist firm is saying that you know the sector better than the management team.”
Question number one: Does an interested private equity firm have requisite expertise and experience in your sector?
So, aside from making sure that a possible private equity backer can demonstrate knowledge of the sector, what else is important when it comes to finding the best possible fit. One of the clear ways of differentiating between houses is the extent to which each takes a hands-on approach to portfolio companies.
Nick Jones, partner at Cavendish Corporate Finance, an advisory firm that has advised the founders on recent deals including the acquisition of Naked Wines by Majestic Wine and investment by ECI into Avantia, explained that in most cases now management teams are looking for someone to work with.
“As an advisor trying to win the mandate, you absolutely have a role to play. Your job is to make clear how a firm operates, what it does, the degree of support they can offer and who they are going to put in as chairman,” he added.
“You also need to communicate the rights they are going to have on the board and what access they can bring to specialists outside. The key thing, however, is how real that is as opposed to what is just a sales pitch. Is what a firm is outlining genuine and does it work 100 days after we have done it?”
Jones advises management teams to ask those awkward questions, because once the deal is signed it can be too late. Even in the frenetic pace of getting a deal going and eventually closing it, there is still time for those all-important queries.
On the same issue, Deloitte partner Simon Barrass has found that the management teams which end up being the most successful in buyouts are those who are receptive to positive input. “So it shouldn’t matter to them whether or not a private equity house has an operating partner who can come and add value to the business,” he commented.
“When buyouts fail there is usually a breakdown between the management team and the private equity house, and where there is inherent resistance from the management team to that change.”
This demonstrates the importance for a management team and its leader to establish early on how involved a private equity backer intends to be, and whether that fits with the plan going forward. Smart cash is better than cash, but only if a team intends on using that intellect.
Question number two: Are you getting involved with a private equity firm that prefers to be passive or involved and does this match what you need?
Expanding on the theme of teams, the discussion then moved to the kind of people management teams can expect to work with though the process of a deal and subsequent portfolio position. Whereas some houses will have a partner who will be the designated lead right from deal origination to eventual exit, others prefer to assign one for dealmaking and another for management.
Liberty’s McDonagh said: “A lot of management teams are looking for relationships, and for those relationships to build – some continuity is usually preferred. That said, each business and management team is different, so you have to put together something bespoke in each case.
“By and large management teams like continuity, but equally they are very happy for portfolio management people who have specific skills and expertise to bring to the table to get involved.”
The skill sets of the dealmakers and the portfolio managers are different, believes Cavendish’s Jones. The attention of a dealmakers can wane after closing, when the details of operations and management become the focus. They are just different characters, he concluded. “My take is that it is important for transactional partners to take a seat on the board and maintain the continuity and relationship, but it is worth having another person who is really interested in the operational matters of the business joining the board too,” Jones added.
Lewis Bantin, partner at ECI, stated that, with the contact getting formed in the crucible of doing the deal, the lead transactor is key in forming that relationship with the chief executive or founder. The way his firm builds its commercial team is to be joined up within that process, so that they are part of the overall package the investor can offer that the management team are buying into. This also introduces the management team to the two or three individuals they will be working with going forward.
“There used to be a view in the market that you did the deal and then watched the business for six months to see what it was,” he remembered, “but it has got to the point now where you have to do your diligence well, understand the business and have a point of view about what you think will be the right direction for the business. You want to get on with that early and get the agenda set together, right from the beginning.”
Question number three: How is the house structured, will I have a different point of contact for transaction and management?
With a big chunk of change dropped into the business account after signing on the bottom line, it is logical to think big and target the big time. If your company has saturated the domestic market, now will seem like the right time to look overseas. But here again it is important to find the right backer.
Larger private equity firms with offices dotted throughout the world will logically have a bigger network to exploit and help a portfolio business become successful in new international territories. However, smaller houses can still prove worth by demonstrating what has been done with historical investments.
“How we internationalise a company is something we have debated internally. Do we join an affiliate network or do we open an office in an emerging market somewhere?” Bantin explained.
“You also have to ask if building up an office network is actually going to serve the business you invest in. During the last five years I have had one business ask me about opening in Brazil, but for most companies we have worked with it is about getting into the US or getting into Europe.”
Bantin cited the example of Wireless Logic, a technology company ECI sold to CVC earlier in 2015. Breaking Europe was the most important thing for that company and with ECI’s help they opened offices in France, Germany and Spain to cement the business as the clear European market leader. In its active portfolio, ECI has one business headquartered in the US and a number of companies with “substantial operations” across the globe – with one reaching as far as Africa, South Asia and Australasia. He advised: “Look at the portfolio of the fund and look at what its businesses have done and where they are based.”
Examples of being successful on an international stage is something Barrass also expressed as being critical. Key for a private equity house in an auction process is to outline the “proof of concept” in taking a business overseas. “If a private equity firm can outline how exactly that will happen, even if it is just one market like France or Germany, that becomes a very interesting story for a management team.”
Question number four: Does a bidding private equity firm have the network or track record to support international expansion?
The debate held by the seven Real Deals roundtable contributors all came down to one thing, does private equity add value beyond the cheque that is cut?
For Bantin, private equity can add a lot of value to an entrepreneurial business. The key, he believes, is for the chief executive to get under the skin of an offer in the lead up to a deal and discover if it is really there. “What did the fund to do make a difference in their last three exits,” he suggested.
McDonagh said: “The buyout market is so competitive that value-add needs to be a fact, but I sense that there is still a lot of friction out there. Buyout firms need to accept that they can’t be all things to all men and focus on the areas where they can drive genuine change.”
Frank Carter, partner at KPMG, called for private equity value-add to be “real and demonstrable”. If a house can show it then it will be differentiated and the “market will take note”.
As someone who has been part of the private equity process a number of times, Tenwick sees the finance and growth route as one that is worth looking at. “If you look at the overall capital markets ecosystem and the choices available to management teams, public markets are one route, becoming part of a larger corporate is another or you can look at private equity,” he said. “As a source of capital that can drive value and help companies do that faster, private equity has much to offer.”
Question number five: Will a private equity backer provide real value-add, and how can they show this pre-deal?
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