Dealmaking in a new decade: Selling a business to trade and private equity buyers

What is the main difference between corporate and private equity exits? What are the best strategies when selling a business to private equity and how do these differ when selling to a corporate?

These questions were put to a panel of corporate vendors and private equity specialists at a Mergermarket seminar this month.

Over the last five years BAE Systems has made £5bn of corporate investments and £2bn of disposals. For Steve Beckett, Director of Corporate Strategy at BAE Systems, the biggest issue for anyone contemplating the sale is actually making the decision to exit.

According to Beckett, the issue to be addressed is whether more can be achieved with the money and resources available by making an exit rather than by keeping the business.

From a corporate seller’s perspective, a clear understanding of the core competence of the company is vital. Beckett says it is never about selling a business that is failing. Often people get out because, although they are running a successful business, they realise that others are in a position to realise more value out of it. Part and parcel of this is to have a good idea of what alternative use the sale proceeds would be put to.

Sean Whelan, MD of ECI partners, says that, unlike corporates, private equity buyers are always in the knowledge that they are going to be selling their holding, which they will typically exit within two to five years. From the very moment they look at a prospective company to buy, they are thinking: can we sell it? Often they will know very early on, even at the purchase point, as to who the likely buyers will be.

During the entire holding phase, the private equity (PE) firm will be gathering intelligence on the buyer community. Some of this will be gathered in-house, but often it will be outsourced to advisory firms.

Unlike a corporate, their PE firm will never really consider their own corporate strategy in the company buy/sell process. They remain focused on the target, paying particular attention to the track record and ability of the management, continuity of management, clarity of the offering, visibility of earnings and related factors. They are also keeping the other eye on prospective buyers – at what point will it be right for a strategic buyer to be acquiring an asset? Timing is key.

Stuart Licudi says that his private equity firm, William Blair International, sells over 70 per cent of its companies to strategic buyers. In his view, private equity buyers are more ‘professional’ in their approach. They will obviously not be buying for their own strategic reasons, so they need to be able to see clear value in the acquisition proposition.

The timing perspective also differs between the two types of vendor. Corporates have usually had the business for many years, so selling up, when it happens, is part of a mature process. This view is shared by Cyril Court, Managing Director of HSBC’s Equity Capital Markets, who agrees that private equity firms are more likely to have been owners for only a few years.

Stewart Licudi adds that there are two different periods that form part of the corporate sale process - the fixed period and the flexible period. The fixed period commences when discussions begin with your first prospect. Before this is the flexible period when all the fundamental housekeeping issues need to be ironed out and sale preparations completed. So that when the fixed period commences, the management can concentrate on selling the business. Though sometimes in the case of an entrepreneur-controlled business, the owner knows he or she must move quickly lest they have a change of mind.

Pointing out a further difference between private equity vendors and corporate vendors, Cyril Court says that corporates have other concerns, including social and regulatory complexities. The corporate seller also has to ensure that the rest of the business is performing throughout a sale process. They are not in the business of trading assets, unlike private equity firms, who are professionals with much experience and knowledge in the area. Sean Whelan adds that private equity buyers are more difficult to deal with and the level of scrutiny is higher, as there is no strategic consideration. However, overall there is a higher chance of deliverability.

Beckett at BAE notes that many larger corporate sales involve divisions or subsidiaries. The company needs to have a clear and credible business plan. It is vitally important to understand the boundaries of the division or business that is to be sold, and for the need for those boundaries to be sensibly set. How will the sale affect the rest of the group? Can the division be self-sustaining? The disposal process can be disruptive and should therefore be a different team running the disposal process to that running the day-to-day activities of the business. Beckett points out that the separation of IT can be difficult and time-consuming, as can pensions. These areas should be addressed before the sale process begins. It goes without saying that stand-alone accounts should be pre-prepared and these should preferably be audited.

Business valuations
There was a consensus amongst the panel that nearly all business owners think their business, their baby, is worth more than it really is. No matter what the market is prepared to pay, the owners will often apply the highest EBITDA multiple they can find in the sector. Sean Whelan, quite correctly, points out that business valuation is not a science but a black art. His advice is to use industry multiples only for directional guidance, and to also refer to DCF figures and genuine comparables. From a private equity buyer point of view, he needs to understand how much cash the business is generating in order to calculate how much debt can be repaid.

For Stuart Licudi, business valuation is always a central topic of conversation in his company. The key is to manage the expectations of the vendor. After the valuation calculations have been done, it sometimes has to be said that the baby is, in fact, ugly! The application of valuation science when corporate strategies are involved is very imprecise.

The important thread is understanding potential purchasers, says Steve Beckett. Who they are. What they are looking for. What likely value they will see. It is worth bearing in mind that different buyers will want to know different things about the business. He adds that it is imperative to understand the level of preparation required for the sale process.

Cyril Court of HSBC says that both investment banks and strategic buyers are likely to offer a range of valuations, but it’s not advisable to automatically go for the one that offers the highest price. A purchaser that can easily back up his/her numerical assumptions and is more likely to deliver the transaction, is a better horse to back. On the whole, private equity buyers are more reliable on this level.

Stuart Licudi adds that private equity companies are more innovative in structuring deals. Having said that, debt equity levels are much lower than they used to be and although they are slowly climbing back up, it is still more common to see the ratio at 50/50 than 70/30.

In order to get exclusive info early on in the sale process, a potential purchaser needs to be paying a premium, says Sean Whelan. Cyril Court of HSBC agrees. He adds that this is particularly relevant for single owners or family-owned businesses. You don’t want to lose sight of plan B, i.e. keeping the other interested parties in the loop.

Legal Differences
Oliver Stacey of law firm Norton Rose says that there are often differences in terms of the readiness of the corporate and the private equity seller. In many cases corporate vendors do not have all the information required in a transfer of assets. Often there are not even standalone accounts in place, and this all extends the length of time required to complete. The management, in some cases, is not even aware a sale is going through. In contrast, the private equity firm knows exactly what metrics need to be measured, what documents and contracts need to be checked, filed and recorded, They also have the right systems in place to manage the process.

His advice to corporates that want to speed up the sale process is to minimise the risk by identifying potential problems early on. The seller needs to carefully plan the timing of when any negative aspects are to be revealed to the buyer, and this is an important part of the sale negotiation.


Other Exit Options
A dual-track IPO/trade sale process is not applicable to small businesses. The consensus is that there is not much point for medium-sized companies with revenues of over £10m unless the IPO is used to smoke out potential buyers. The business seller needs a different set of advisors to run the trade and public sales. It is an expensive strategy that needs to be fully thought through and planned well.

Over the last two years, Sean Whelan has exited over 80 businesses and only one was via an IPO, and considers that it’s not an appropriate option for any businesses turning over less than £100m. IPOs are not popular in the current climate. Crucial to the decision to float is whether management want to be part of a public company.

Secondary IPOs, on the other hand, are a very poplar strategy now. According to Whelan, secondary leveraged buyouts (LBOs) now account for about 60 per cent of the private equity marketplace activity: they are a serious exit route. Private equity firms have to keep trading and need liquidity. So there is usually value left in the companies they sell. Whelan will often run a private equity sale process alongside a trade process, and an auction can often ensue.

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