The expected frenzy of private-equity deals in 2014 hasn’t quite come to pass. For CEOs with an eye on the exit, a secondary buy-out remains the likeliest route, with many opting to roll with a deal so they can keep building the business. While the opening up of the public markets is certainly another welcome option, trade buyers are continuing to show caution due to perceived overpricing.
Indeed, with the availability of debt back at levels seen in 2006 and 2007, valuations have been the sticking point for a number of transactions. “Pricing expectations are high,” says Stuart Coventry, Partner at corporate finance firm Jamieson. “Bids often come in below where the sale-side expectations were set, and those expectations have probably been built on the back of a very bubbly IPO market earlier in the year."
To maximise the value of a sale, the CEO and management team need to stay focused on the fundamentals. Rob Crossland, Chief Executive of employment services company Optionis, which completed a secondary buy-out through MML Capital earlier this year, says that “in any kind of exit you need to demonstrate how the business has grown under your tenure but, equally, why there is more growth to come”.
The potential for scale is what drives value, often through global expansion. Simon Tilley, Managing Director at corporate finance firm DC Advisory, says: “[PE investors] are getting much more excited about opportunities where there’s either a UK business that operates overseas already, or there’s an opportunity to take it overseas and get more international exposure.”
Grant Berry, Managing Partner at private equity firm NorthEdge Capital LLP, comments: “Nobody wants to buy a business at the top of the market, so it’s important that when someone is coming in on the buy side they are confident about the business being able to grow in the medium to long term.”
Fit for the Future
From the outset, the management team should be assessing the market and deciding upon who the potential buyers might be. Catherine Wall, Non-executive Director at investment management firm Mobeus Income and Growth VCT, says: “What is the totally compelling story for their business? Does this acquisition give [a buyer] entry to innovative or fast growing markets, products or customers? Does it give them new skills or capabilities?”
Ian Edmondson, Chairman and Managing Director of Dunlop Aircraft Tyres, says: “Understanding the likely interest of different potential owners will help to define the exit. This needs to be done by exploring, networking and developing a range of relationships...
“In some cases there may be equally interested future owners from different backgrounds, meaning a possible secondary buy-out might be just as likely as a trade sale. If the current owner wants a complete 100 per cent exit at a point in time, then an IPO is not usually the favoured option.”
Douglas Quinn, Chairman of home-care provider Baywater Healthcare, comments: “You want to end up with a strategy that is very portable. Thinking through all the options and having a range of scenarios depending on the circumstances is very helpful.”
The chairman, usually appointed by the sponsor, certainly has a role to play here in ensuring there is alignment on the exit strategy. Ian Stuart, Chairman of four mid-market PE-backed companies, including manufacturing concern Aspen Pumps, says: “It’s about getting people around the table to talk together and be honest about what they want, and achieve a compromise.
“Specifically, if private equity wants to exit later and the management want to go earlier, you will generally arrive at some sort of incentive arrangement for management to stay longer.”
Of course, preferred exit routes won’t count for much unless the management can demonstrate strong performance, good governance and show there are no nasty surprises for buyers, such as big ticket customer contracts coming up for renewal, leasing issues or weak intellectual property. “You can’t dream those up at the last minute,” says Gerry Brown, Criticaleye Board Mentor and Chairman of logistics concern NFT.
The importance of succession cannot be underestimated. “We worked on the buy side of a deal that fell through over the summer, where the owner CEO wanted to exit but there was no work put into succession planning – it’s just awful when you see that happen,” says Simon. “It’s partly down to the value, because you won’t get the same price as if you’ve got a strong management team solution in place, but it also comes down to deliverability and, in this case, they couldn’t get the deal [finalised].”
It comes back to having a long-term approach so that the business is an attractive proposition. Tania Howarth, Chief Operating Officer of frozen food company Iglo, says: “Any PE-backed CEO has to balance exit considerations with the need to focus on building a strong, sustainable business…
“From the beginning, a CEO needs a strategy to build a better business and then understand where on that journey his or her current investor will exit, so that the business evolution can be tied into the investor goals.”
Every step must be taken to eradicate easily avoidable mistakes that either damage a valuation or scupper a deal. After all, the exit process will be demanding enough for a management team, without them having to address deep-rooted issues in the business at the last minute. Ian Stuart says: “Don’t get so distracted by the exit that the company goes haywire in the meantime. You’ll then almost certainly have a bad exit if results fall away.”
According to Rob, it’s important to keep having conversations around the exit. “Having done it twice now, [I know] you need to be discussing it sooner rather than later. It should definitely be on the strategic schedule for review at regular points as, if this isn’t the case, there’s the danger of becoming misaligned and unclear about the future.
“Private equity, I think, has a bit of a challenge, because initially they don’t want people talking about exit… They want them focused on the day job. If they let that continue, I think that can create some difficulties down the line.”
Timing has a part to play in any sale and that’s not necessarily something that can be controlled. Pardip Khroud, Investment Manager at private equity firm LDC, comments that political and economic uncertainty can suddenly have a significant impact on the behaviour of buyers. “It makes businesses far more difficult to value and deters potential buyers from committing,” she says.
The nightmares of private equity occur when communication breaks down between sponsor and management team, resulting in misguided assumptions. It largely falls on the CEO to ensure this doesn’t happen, so there is a healthy focus on performance – short and long term – which is what will matter the most when a potential buyer does come along.
As ever, a little luck always comes in handy too.
I hope to see you soon