Pre-empts: Racing ahead
What have we seen in the market and what are we talking about?
There has always been a number of transactions each year where the successful buyer moves at a startling pace. Collectively when we talk about a “Pre-empt” there are a few alternatives in practice. Bidders may start in a structured process running among the pack in the normal way then rapidly accelerate ahead of others with the deal signed soon after the initial bid deadline. The less common, and arguably the variant that presents more challenges, is when a prospective bidder delivers a deal either completely ahead of a formal process beginning or indeed without the target even being formally prepped and “for sale”.
Why does someone want to pre-empt?
With ever more funds competing to deploy capital, higher quality assets will attract early interest from those sponsors who have the appetite to invest the time, and money, in pursuing them.
With covid limiting the supply of available assets, but not especially diminishing the amount of capital in the market, we have seen a marked increase in the number of processes where parties either pre-empt or accelerate.
An owner, manager or sellside advisor working with a high quality asset can perhaps now assume that as a default this is most often how their process is likely to pan out.
A buyer wants to avoid the risk of missing an asset they have been tracking; they will likely have invested considerable time in market mapping, undertaking in-house and external market diligence, building their own picture of the business plan opportunity, bringing their investment committee on board to the potential opportunity and developing a relationship with both the existing owner and management team.
In many cases, this market tracking activity is exceptionally thorough and many of the more sophisticated players will engage in this activity almost immediately after the point that the current owner acquired the business.
With this focus on certain identified targets, the funds that engage in this activity perhaps feel more comfortable in putting forward an offer ahead of time or running faster in a process as they feel their knowledge of the risks and opportunities are much more developed.
Approaches to pre-empts
As mentioned earlier, there are different scenarios which are generally referred to as a pre-empt ranging from:
- simply accelerating during round one or two whilst already in a process
- bidding early and seeking to agree a deal before a process has fully launched, often as one of a small select group who have early access to the diligence materials and the business
- a bi-lateral discussion where a deal is agreed completely ahead of any process, often before M&A bankers have been appointed and any meaningful prep work has been done
The first and second of these scenarios should be relatively straightforward for all parties to manage, with the key point being the ability to deliver the relevant diligence and other materials to the buyers who are pushing faster so that they are able to maintain momentum.
In order to have a pool of prospective pre-emptive parties in the first place, it will be important for the current owner and management to invest time and engage with credible parties through the life of the investment, whilst care must be taken to not get overly distracted with speculative discussions it is helpful for all concerned to educate and engage with potential suitors.
Benefits and risks of pre-empts
The benefits to a successful pre-emptive buyer are clear; avoiding the transaction risk of a competitive process. For obvious reasons it is impossible to determine if there is a pricing advantage for the buyer in a pre-empt, and intuitively it does not often feel like a pre-emptive party does get any kind of price advantage however there may be occasions where the certainty and deliverability of a highly credible pre-empt, coupled with being the “right” partner, may also bring some price advantage for the buyer.
Turning to the Management’s position, a pre-empt can often be a great outcome for the team. With a buyer looking to work any angle possible to secure the pre-empt, putting forward a compelling management package and not picking fights or getting into the weeds on the management terms can massively help to put Management on side and win their support. The more enlightened bidders will understand this point and use it to their advantage, whereas making sure the vendor is happy but ignoring or kicking the Management can down the road will often end with an unsuccessful outcome for the pre-empty party so should be cautioned against.
For the seller, the speed and certainty of a pre-empt coupled with (in the current market at least) fairly full pricing can make it a great option too. However there are several risks to consider:
- Is the party really credible or do they have a history of “fishing” trips
- If the pre-empt discussions leak out, then this will almost certainly harm or completely halt the potential for a fuller process
- Should the pre-empt not conclude successfully then as well as the general distraction factor to the business there is the potential for the market to hear that someone looked but didn’t buy which in itself can make any later process more challenging
Ultimately, if handled well, a pre-empt deal can be a great outcome for buyer, seller and management alike.
Where do we see the market going
With the continuing growth in the pools of capital in the private equity landscape, it is hard to see pre-empts slowing down overall however once the world recovers from the covid pandemic and (hopefully) more sectors come back on the radar for private equity we may see some calming of this activity. That said, the more sophisticated and motivated funds will no doubt continue to push hard to buy assets outside of processes where possible, with owners and management teams alike benefiting in terms of the prices and equity terms achieved.