World of M&A has changed a lot due to equity fund participation in recent years. There are thousands of such funds in 2014, and they offer a whole new possible direction for would-be sellers.
The equity fund buyer is a different beast to deal with for owner/sellers of companies.
First of all, they commonly don’t have the depth of understanding of the industry that the normal strategic competitive buyer would. They need more information about industry trends, current pressures within the industry, and general prognosis for the forward future.
Also, equity fund buyers are very used to a heavy competitive field of alternative buyers participating in almost every transaction they consider. In order to win the opportunity to be the successful buyer, equity funds seek to eliminate the seller’s discussions with alternative suitors as quickly as possible. Long before they have completed all of the due diligence they would expect to do pre-closing, they will generally seek to obtain a signed letter of intent with the seller. The letter of intent will generally say something about expected price, will say the buyer now has open access to further due diligence information, and will say that the seller agrees to have no further conversations with other potential buyers. The buyer will retain full rights to back away from the transaction, if for any reason their due diligence causes them to not wish to proceed. Thus, the seller really gets nothing at all from the Letter of Intent. Buyers – particularly equity fund buyers – will put great pressure on the seller to sign a letter of intent, to reduce their risk of a failed transaction after they have spent significant time and money in the due diligence effort.
In our first 10 years of operation as seller reps, we never had one single letter of intent that failed to close. However, also during that time, virtually every transaction we did was with a strategic buyer. Equity funds simply were almost never competitive in price. Today that is not true. Today equity funds often compete at very close to a full competitive price, similar to what might be obtained from market competition with all sorts of buyers. However, equity funds are seldom as firm about their decision to purchase, as someone with greater industry background might be. Equity fund buyers will, perhaps a third of the time, decide after due diligence, that they do not want the purchase. When that occurs, the seller is back to the market, usually with a significant “black eye” in the view of alternative buyers he spoke with earlier. The other buyers know that a transaction was planned and accepted, because the seller had to cease talking to them when it happened. They then worry about why the transaction was later called off. If the seller goes back to revisit with them later, they usually will pass, and will not continue to pursue. They assume the alternative buyer found out something significant, which caused them to decline.
So – for the seller of a company, with this increased risk of potential failure to close, why might he consider sale to an equity fund instead of to a more traditional industry player?
If the seller/owner would like to continue working, the equity fund can leave the door open for that in a nice way.
The equity fund buyer would usually much PREFER to have a continuing owner to help with ongoing development of the company. It can be the alternative that leaves the owner in greatest ongoing control, to keep running the company, while still allowing great reduction of personal financial risk. The owner no longer has to personally guarantee outside debt, and they usually have substantial capital if needed for future operations. Expertise for examining possible add-on acquisitions is excellent, and cash for equity needed is usually ample.
We have seen owners who, post-sale, thought they would like to leave the company quickly, who have changed their minds within a few months, because the equity fund buyers found resources to take over the things they least liked doing. Suddenly, when they no longer had to do financial or personnel management (whatever they least like), they again were having fun, doing only sales activities, or technical development (whatever their personal favorite “hot spots” might be).
This is not to say that the equity fund buyer is always the easy solution. Some owners, who are annoyed by not being in full control, have found the opposite true. When they suddenly have outside oversight to everything they do, that sometimes can be an uncomfortable adjustment. But, it may be worth the adjustment, and it may result in a better run business for the future.
If the seller’s industry is one where there is a very significant consolidation trend, it may become increasingly hard to survive, without being part of a much larger organization. The equity fund “roll-up” might be away to accomplish greater mass, without the requirement to hook–up with the larger long-term competitors in the industry.
When the seller owner really believes they would prefer the equity group buyer, what is critical about next steps to nurture likely success?
When we work with equity fund buyers, we go to great lengths to try to ensure that they know everything about our client that may be critical to their decision later. (We hope to reduce the potential for a “false start” by being very thorough and direct with information.)
We talk with equity fund buyers in detail about all significant aspects of the transaction, and document our agreement about those details in the written letter of intent. This includes, for example, terms of the amount of cash at close, structure of any notes payable and related collateral, outlines of any expected reps and warranties, details of employment agreements, related party rentals of real estate, and more., Also, we keep the timeline tight and clearly defined, to ensure that if the deal fails, there is time for the seller to reconsider alternatives. We have learned over time, that the more details are worked through in advance of signing a letter of intent, the more likely parties may get to close quickly and successfully.
Strong equity interest in an industry is a good thing. It gives owners greater range and flexibility in planning possible equity transitions. It allows highly professional expertise in the planning and execution of consolidation efforts.
Equity fund buyers are a different experience for seller to deal with, but they can be well worth the effort.