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Private Equity’s Pursuit

By Bill Rosin

Over the past decade, the private-equity industry has expanded dramatically, more than doubling its assets under management to nearly $2.5 trillion in 2016. This remarkable growth has been fueled by a number of factors, including a favorable marketplace and an extended period of low interest rates. With economic conditions remaining conducive to growth, private equity firms and funds have found themselves not only in the black, but in the enviable position of looking to put more of that cash to good use. Consequently, they have become more aggressive about seeking out promising investment opportunities, and this has contributed to a growing trend of private businesses selling to private equity firms.

The surge in private-equity transactions has been evident in a wide range of different industries, from automotive to food services. The manufacturing sector is no exception. With private equity interest in private businesses perhaps at an all-time high, manufacturing executives and decision-makers would be wise to educate themselves about the various considerations and consequences that should be taken into account when negotiating these deals. Understanding the legal and logistical landscape of private equity deals is an important first step toward preserving leverage and maximizing returns if a sale moves forward.

Either-or

Understanding what kind of buyer is right for you is obviously a critical first step. Does a private-equity sale make sense for your manufacturing company, or would a more traditional strategic transaction be a better fit? Every business is different, and every leadership team or decision-maker has his/her/their own set of personal and professional circumstances to consider, but there are certain consistent factors that should be taken into account when evaluating whether a private equity sale makes sense for you. Regardless of any board or business’s preferences and priorities, a good place to start is with the fundamental question: what’s the point? In other words, what is the motivation behind the sale, and what is the ultimate goal of those with a stake in the outcome?

Private-equity transactions might be a good fit for an energetic manufacturing owner/operator who wants to remain an active and engaged part of the operation, for example. Private equity buyers are more likely to preserve the existing management structure and tend to prioritize continuity when it comes to running the business. Along those same lines, private equity buyers are also more likely to rely on the existing management’s insight and experience when it comes to making decisions in the wake of a sale. Private equity buyers are buying to sell, and are typically more than happy to keep a successful business humming along smoothly without expending unnecessary resources to make a change for the sake of making changes. Strategic buyers are almost exactly the opposite: they are far more likely to make sweeping changes. Leadership changes, big employee restructuring, repositioning assets and even relocating the business are not uncommon.

Dollars and sense

Strategic considerations aside, money talks–and oftentimes speaks louder than anything else. For many sellers and buyers alike, the single most important issue is the price tag. Here again, there are key distinctions to be made between a private-equity transaction and a more traditional sale to a strategic buyer. The latter are more likely to offer more money up front. Every prospective purchaser and every transaction is different, but in general, strategic buyers are more willing to pay a premium price for intangibles such as expanded market share or other proprietary/competitive advantages. In contrast, private equity buyers tend to adhere to a specific formula that accounts primarily for tangible assets, earnings and cash flow.

For sellers that have the freedom and flexibility to be selective about their buyer (and not all do, of course), the bottom line might be just that: the bottom line. The highest and best-possible valuation they can realize for selling their company might be the single biggest consideration. Other sellers may want or need to weigh other factors when determining buyers or considering offers.

Manufacturing dynamics and disclosures

Among the most complicated sets of issues that manufacturing professionals face when entering into a potential private-equity sale are those industry-specific complications that can potentially throw a wrench in the works of a transaction. Due diligence obligations are important in any industry, but can be a particularly urgent priority in the manufacturing world.

A private-equity firm buying a consulting company, for example, is a fairly straightforward transaction. A manufacturing operation, on the other hand, could have a host of complex environmental and regulatory liabilities that need to be disclosed and the volume of due diligence information is substantial typically requiring the use of a virtual data room. Private-equity buyers are making initial valuations and extending offers based on a “snapshot” of the business and its operations as presented in the seller’s materials. If it is discovered that a storage facility is leeching hazardous materials into the ground, or if a permitting issue arises because of emissions violations, the terms of the sale could be radically altered in a moment.

With that in mind, it is paramount that the seller know and understand the business, warts and all, and that the information provided to the buyer is accurate and complete. The seller will suffer a credibility hit and will almost certainly lose deal leverage if any undisclosed issues arise during the buyer’s comprehensive due diligence process, and that can have a significant adverse impact on the final sale price or even kill the deal itself.

Expectations and experience

One of the advantages of working with large/established private equity firms is that they almost always have an experienced team of professionals (including legal, accounting and investment advisory experts) in place. This is not their first rodeo, and the negotiation and sales process subsequently tends to be fairly efficient and straightforward. Sellers would be wise to bring in experience and expertise on their side of the deal, as well, in the form of trusted legal counsel (ideally with Mergers & Acquisitions and private equity transactions experience). An experienced legal representative can not only help you establish realistic expectations, but should be able to provide insight gleaned from industry-specific experience and the perspective that comes with extensive transactional market knowledge.

The earlier in the sale process that you engage legal counsel, the better, and the more likely your objectives will be achieved. Make sure that you communicate clearly with your legal representative about what you hope to get out of the transaction. To be an effective advocate for your interests, and to guide you efficiently through the sale process, your lawyer(s) will need to understand your goals and objectives. That process may include providing counsel in the selection and hiring of an experienced investment banker to assist with transactional details like pricing, marketing and identifying bidders. It will almost certainly include helping with deal structure, negotiating with the buyer’s legal counsel and performing/coordinating the due diligence, particularly the initial due diligence incident to getting the company ready for sale. Completing appropriate internal audits (including legal, corporate and financial due diligence) early in the process is critical to avoiding late inning surprises that will compromise leverage and value.

Ultimately, of course, that’s the name of the game: the lawyer should endeavor to maintain deal leverage while counseling the manufacturing decision-makers through the sale process to maximize value and accomplish the seller’s goals and objectives.

Read the original article on Manufacturing Today.