Management Buyouts in the New World; James Trevis, Private Equity Partner at Eversheds LLP, the International Law Firm, Outlines How Talented Management Teams Can Engage in Buyout Transactions to Seize the Opportunities Presented by the Current Economic Climate
Byline: James Trevis
Q 1 of 2009 saw private equity investment activity hit its lowest level since 1996, with the restricted availability of debt finance continuing to hamper buyout activity. This is despite private equity firms having enjoyed record breaking fundraisings in the recent boom years, with capital needing to be invested to achieve the required return for their investors. History has also shown that it is often those deals which are struck towards the bottom of a downturn that go on to deliver stellar returns, largely as a result of investors being able to buy at competitive prices and maximise the benefits of the recovery that follows. So, how can ambitious management teams seize the day and ensure that they generate wealth for themselves and their private equity funders? As a first step, management teams should evaluate the dynamics of their business to identify whether it is appropriate for a buyout. Is the business currently viewed as, or likely to become, "non-core" to its parent group? If so, the parent may wish to dispose of the subsidiary in order to realise funds to invest in those business areas that are core, particularly in the current environment.
Groups with a high debt burden may be required to raise funds at short notice and compelled to accept a forced sale of the business to raise those funds. In such circumstances, management may be the only potential purchaser able to meet the short timescales required.
The nature of the business itself should also be considered. Is it capable of operating as a commercially viable standalone entity, generating adequate profit and cash to sustain the business and its development, the financing costs associated with the buyout, and without over-reliance on intra-group trading or services? Thirdly, management teams should also engage in some critical self-analysis to ensure they are presented to investors in the best possible light. Is the team well-balanced, motivated and committed to a buyout opportunity? Can they demonstrate a track record of generating wealth, either for themselves or their employers? Importantly in today's market, can they show that they have operated successfully in recessionary environments before? These were, of course, all key considerations during the boom years, although they are now being thrown into sharp focus in the downturn, with only the most robust investment propositions likely to be of serious interest to investors.
Having assembled these key ingredients and attracted investor interest, management teams will need to be alive to the new environment of dealmaking.
Private equity sponsors and lending banks will be focusing on due diligence matters with renewed vigour, seeking to ensure that in addition to forecasts being prudent and defensible, there are no legal risk areas that threaten to undermine the performance of their investment.
Management teams should therefore seek to ensure there are no skeletons in the cupboard that, despite relating to the vendor's period of ownership, could be viewed as risk issues from the perspective of the investor.
Management teams should also be mindful of likely transaction structures in today's environment. With bank debt remaining scarce, we are seeing term sheets with a high proportion of vendor finance, in which the vendor actually agrees to lend the purchaser a portion of the sale price. This can be structured as a straightforward term loan, although may involve additional rights for the vendor, such as warrants (options) to acquire shares immediately before an exit. In this way the vendor is compensated for the risk it is taking on the creditworthiness of the buyout vehicle. …