What are the key considerations when selling a stake in your business to private equity?

Selling a stake in your company to a Private Equity (PE) firm can be, for many business owners, a great option; but there are a number of additional considerations that an owner-manager should bear in mind when comparing a PE investment to a normal trade sale. Each PE investment is different and some of the considerations may be more or less relevant depending on the equity stake taken by the PE firm (i.e. 100% sale, majority stake or minority stake). We have summarised some of the main considerations in this article.

Adding expertise and driving growth

The primary aim of the PE firm is to invest in your company and further its growth with a view to maximising the company’s value for a later full sale (or IPO) within a set period of time. The investment period varies on each deal but it is likely to be around 4 to 7 years (although we have recently seen PE firms take a longer view on their investments).

As part of the investment, the PE firm will usually take an active role in the company and its future growth plans.  For example, the company will benefit from the expertise of the relevant members of the PE firm who will be able to share their knowledge and assist with the strategic plans of the company.  It is common for a member of the PE firm to take a seat on the board of directors of the company.

The company will also benefit from any further investment the PE firm decides to make into the business. By way of example, some PE firms will help the company fund further acquisitions to assist with its growth (usually referred to as “bolt-on” acquisitions). This equips the company with another source of funding to further enable growth.

Reduced decision making powers

The main disadvantage of any PE investment is the reduced freedom for the owner-manager to make his or her own decisions about the direction of the company. If you have previously run the company yourself, selling a stake of your business to a PE firm will significantly reduce your ability to make decisions without consulting the PE firm or in the case of particular material decisions, obtaining their express consent. At the point of the investment, an investment/shareholders’ agreement will be entered into and the articles of association of the company will usually be amended to reflect such restrictions. Along with various other amendments, the PE firm will insist on a number of reserved matters which cannot be carried out by the company without the PE firm’s prior consent.

Another important point to consider is that PE firms will usually insist on the existing management team and/or current owners staying with the business for a number of years post-investment (and often until the point the PE firm itself decides to exit the company). Our PE clients frequently note that they prefer to back “management teams” rather than “businesses” when looking to invest. It is, therefore, essential that the PE firm and the management team can work well together. It is often the case that PE firms require the owner-managers to “rollover” some of their sale proceeds by reinvesting into a special purpose vehicle (usually a brand new private limited company) that is buying the company itself. This enables both the PE firm and the rolled-over owner-managers to benefit from any potential future increase in the value of the company (but equally, both parties will then share in any decrease in the value of the company).

When considering the details of any rollover proposal, it is important to be clear at the outset as to the level of management charges which the PE firm will be levying on the company. These charges can be high and this may have an impact on the profit/EBITDA of the company, which in turn may impact the company’s ability to achieve the financial covenants contained in its investment agreement. These financial covenants are promises made by the company and if any of them are breached, many investment agreements will permit the PE firm to take full control of the company.  These financial covenants are usually negotiated at the point of the investment so it is important that the company considers carefully the likelihood of achieving these covenants.

While PE investment can be an excellent way for businesses to accelerate their growth plans, any company considering this route should be mindful of the wider impact PE involvement will have on their organisations. It is vital that any business owner takes advice as early as possible so that they understand the full implications of accessing PE investment and can take an approach which will best suit their individual organisation and specific business plans.

If you have any questions about this topic, please get in touch info@ts-p.co.uk