At the best of times, a genuinely successful private-equity backed exit requires a blend of skill and luck. Evidently, current market conditions remain far from ideal and that puts additional pressure on management teams, chairmen, advisors and PE firms to be aligned and clear from the outset about the best strategy for a sale.
John Cole, a Criticaleye Associate and ex-chairman of valet and car cleaning service Motorclean, which was recently sold in a secondary buy-out, says: “Ideally you should have an exit strategy at the time of buying the company, or, if you have built up the company from scratch, then some years before the exit process begins.”
All too often that basic principle can be lost on management when they go through the process of attracting a third-party investor. Robin Shepherd, a serial entrepreneur who has worked with PE firms and is currently CEO of home-audio and visual business Cornflake, says: “You have to write your exit strategy as part of your initial business plan. It’s important to identify what your fundamental business objectives are.”
Although that initial plan will pretty much be guaranteed to change, it’s necessary so that expectations on all sides can be managed. Whether it’s a trade sale, secondary buy-out or an IPO, there has to be general agreement about what each route means for management and investors.
Tim Farazmand, Managing Director of Deal Origination at PE firm LDC, says: “It’s about where the management team want to be or what they want to do after the deal. If it’s a trade sale, they need to think about how their role and position might change post deal, while there are certain boards that won’t work in the public market space. For me, that would discount the IPO as an exit route so you examine trade or secondary routes.”
In an ideal world, a wider number of routes will increase the chance of getting a good exit. Alex White, a Partner at professional services firm BDO Corporate Finance, comments: “The first thing in terms of maximising value is that the company and the management team are open to a variety of exit options. As soon as you start chipping away at certain options, you reduce the chance to maximise value.”
A robust succession plan will, in many instances, also add real value to a business. If the executive team intend to leave after a deal is completed, a buyer will want to know if there are suitable replacements to fill the gap. “If one or two of the key people who have got the business to where it is want to exit, then you need to have the succession in place to ensure there is continuity,” says Tim.
Meet the chair
Countless stories abound of acrimonious fall-outs between investors and management. In order to help avoid this, John suggests that the exit should regularly appear on the agenda of board meetings so that management grow accustomed to the idea and feel integrated in the process. “A sudden introduction of the subject [of an exit] after a few years can lead management to distrust the motivation of its shareholders,” he warns.
The chairman will be vital as the company goes on its – theoretically, at least – three to five year journey toward a sale. Gerry Brown, Chairman of Novaquest Capital Management and a Criticaleye Associate, comments: “The chairman has a very important role to play because he/she represents the interests of whoever owns the business at the end of the day, but they also have to represent the management.”
It’s a delicate balancing act. “Sometimes there are different agendas and it’s the chairman’s job really to make sure that all parties are represented. That’s not easy, but that’s the objective,” says Gerry.
Robin concedes that the relationship can become increasingly strained. “It’s tough because the drivers of the PE firm can actually be 180 degrees off from what the executives of the business want. Theoretically, the chairman should be sitting on the fence but the reality is that he is the man who has been put there on the PE side.”
In truth, a PE firm ought to consult management in the chairman’s initial appointment. After all, a degree of disagreement and tension may be inevitable in a business when potentially life changing sums of money are at stake, but open warfare and hostility are something altogether different. “The role of the chairman is key throughout the life of the investment, helping the management to understand the process and what is expected of them post process,” says Tim.
When it comes to a trade sale, it usually makes good sense to let it be known that a company is going to be open to bids. “Warming up the market in a controlled and subtle way, ahead of the exit, is very important,” says Alex, adding that this is especially true of the current market where a trade buyer may need a longer time to evaluate the strategic virtues of an acquisition.
“It depends company by company,” continues Alex. “You may get a situation where it’s really obvious there are two buyers that want to pay the most. If that is the case, there ought to be a way of engaging with those buyers years before the exit.”
John agrees. “If you’re operating in a market with few potential acquirers then your business strategy should be designed around appealing specifically to one or more of these potential buyers.”
Unsurprisingly, the element of luck in a transaction comes from the company essentially scratching the surface of its potential earnings, so that an acquirer believes there is ample room to scale the business aggressively. A corporate buyer may pay enormous sums for a new game-changing technology or an innovative service, such as Sun Microsystems’ $1 billion purchase of ‘open source’ software developer MySQL or, more recently, Amazon’s £200 million acquisition of online film rental service LOVEFiLM.
Ian McCaig, the deputy chairman of energy saving company First Utility and former CEO of Lastminute.com, comments that it’s the flexibility of the PE model that gives it a real advantage when trying to build value in a business. “When you are making changes, there are only a relatively small group of people in PE who are making the call. You don’t have to go out to institutions – in a plc, you have a board who you need to get behind the idea. Then you also have to get shareholders behind it and that can be a very lengthy process.
“In PE, you get decisions a lot faster and you can crystallise the ‘yes’ or ‘no’ much more rapidly than you can do in a public environment, to my mind. The PE firm will want robust plans, which is fair enough and they look for clear milestones so you just have to do what you said you were going to do. It feeds into an environment of you being very realistic – you don’t over promise as under delivery has serious consequences and repercussions.”
At present, a large number of deals in the UK and Europe continue to come from secondary buy-outs as firms are under pressure to invest funds. That’s not to say that excellent trade deals aren’t still happening, as of course they are, but an air of caution persists among many dealmakers. “We all thought there would be more exits on the go in the first half of the year,” says Tim. “Perhaps it was just general economic uncertainty that meant exits were being delayed, but we do see some momentum now.”
A lack of realism over valuations remains a barrier to transactions. Gerry says: “The issue is about trust… There is quite a lot of money around, certainly in private equity, but people selling businesses are demanding high premiums, especially for good quality businesses. I think that things are improving but it’s nowhere near what it was at the height of the boom a few years ago.”
It doesn’t help that IPOs remain largely shut as an exit route. In general, conditions are set to remain sluggish with activity levels way behind those in the emerging markets. Claudia Zeisberger, a Criticaleye Thought Leader and Academic Co-Director of the Global Private Equity Initiative (GPEI) at INSEAD, comments: “In China last year 80 per cent of exits came through an IPO, which amounts to around 180 deals… At the moment, growth equity is the name of the game in China.”
Given this surge in activity, it’s not surprising to hear that starting a General Partner (GP) fund is increasingly popular. “The number of new GPs set up over the last 18 months is amazing,” says Claudia, who only sees this trend and the number of exits continuing to rise in the years ahead.
Back in Europe and the UK, it’s a case of having to work hard to get a transaction through. With exits stalled due to the economic slump and some PE funds effectively being forced to sell, management teams must be switched on to ensure that the terms of a deal really do deliver.
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