By Bill Rosin
The private equity industry continues to grow significantly year-over-year, hitting a record $2.49 trillion in assets under management in 2016—a figure that has more than doubled in the past decade. With private equity firms approaching potential sellers more frequently, transactions like the recent Kar Nut Products Co. sale to a private equity fund are on the rise. As this phenomenon continues to become more common, it is important for business owners considering the sale of their business to understand the complex legal considerations and financial ramifications of such deals, including when to bring in experienced legal counsel to help navigate through the process.
The growing trend of businesses selling to private equity firms is primarily being driven by favorable market conditions. Interest rates are low and have remained low for some time now. The economy is relatively healthy and private equity firms and funds are looking for quality investment opportunities. Funds are raising money, investors want returns, so that money needs to be put to use.
Consequently, there has been a huge increase in transactions involving private equity, across a diverse range of industries, including automotive, food services, consulting and more. My practice alone has been involved with nearly a half billion dollars-worth of private equity transactions in the last year, typically representing sellers in those transactions.
Private Equity vs. Strategic
One of the most important decisions that any seller with multiple suiters needs to make is what kind of buyer is a good fit for such seller. Does selling to a private equity firm make sense, or should the seller pursue a transaction with a strategic buyer?
When counseling sellers faced with that question, the answer depends on the goals and objectives of the seller. For sellers who want to remain active in the business, a private equity buyer may make more sense. Private equity buyers are generally more inclined to work with the seller (and the management team) regarding business operational matters. Keep in mind that the private equity buyer is buying to sell, and, from that perspective, the less effort such buyers need to expend, the better. So, it is often preferred that existing management remain after closing (at least initially). Moreover, the private equity buyer’s deal often provides for the seller (and/or management) to have an ownership interest in the business (e.g. 10-20 percent), which can provide a great opportunity to further capitalize on the sale if structured correctly.
Strategic buyers, by comparison, may be less interested in having the seller remain involved in the business after closing (as an investor, officer or otherwise) and are more likely to make significant structural and/or operational changes as they fold the acquired business into their existing operations, which may or may not be consistent with the seller’s plans.
Deal pricing may also vary between strategic and private equity buyers. Strategic buyers may be willing to pay a premium for certain market intangibles unique to that buyer (e.g., expanded market share, the elimination of a competitor or other proprietary advantages). Private equity buyers, on the other hand, tend to employ a conventional earnings/assets driven valuation in developing their pricing model.
Among the many issues that may arise in a private equity sale, industry-specific considerations are among the trickiest. The specific characteristics of the business being sold are important–but the nature of the industry that businesses operate in often carries its own potential complications. Every industry has its challenges, but some are more significant than others. A software company is likely to be easier logistically than a large manufacturing operation, which may have environmental, regulatory, and other issues that need to be taken into account. The seller should engage legal counsel that is familiar with the seller’s business and what is “normal and customary” for acquisitions in the seller’s industry sector.
Where to Begin?
The private equity buyer’s initial pricing and deal terms are largely based on information provided by the seller. If the buyer’s due diligence subsequently reveals “bad news” surprises, the buyer will lose confidence in the seller and, moreover, seek price and/or deal concessions to a greater extent than the buyer may have been able to extract when negotiations first began.
The seller should endeavor to minimize the risk of adverse surprises during the sale process by engaging experienced legal counsel early in the process to, among other things, coordinate pre-sale due diligence of the seller’s corporate, operational and financial matters. The seller must know its business, warts and all, so that the information provided to the buyer is accurate and reliable.
Leverage and Value
Private equity buyers bring a well-oiled machine of experienced legal, accounting, and financial advisors to each deal. The seller must be prepared with its own experienced professionals who are similarly equipped to effectively promote the seller’s interests during the sale process, which includes legal counsel providing guidance in the following key areas: (i) pre-sale due diligence as noted above, (ii) initial deal negotiations and letters of intent, (iii) the drafting and negotiation of the purchase and sale documents, the investment documents and other transaction documents, (iv) working with the buyer’s advisors in managing the due diligence process, and (v) closing the transaction. Experienced legal counsel can also help set expectations, keep the deal moving forward, push back when the buyer is overreaching and contribute valuable industry and market knowledge and perspective.
The seller must engage professionals with extensive mergers and acquisitions experience generally, and with private equity transactions specifically. Ultimately, it’s about maximizing leverage throughout the sale process to preserve deal value and the best way to do that is for the seller to work with a team of experienced professionals who know the seller, understand the private equity buyer, and possess the skills and experience to make that goal a reality.
Read the original article on the Automation Alley blog.