Tim Thomas is a Partner at Liberty Corporate Finance and has been working in the private equity industry for 18 years. Here, he looks at some of the critical interactions between management and bidders during a sale process and how management teams optimise their chances of finding the right investor for their business
Our management advisory role allows us to work very closely with CEOs throughout a transaction, providing us with some privileged insights. The seemingly all-consuming demands of the transaction and the pressure to deliver a successful outcome of a sale process must be balanced with ‘business as usual’ leadership, for as long as the deal takes to close. In particular, CEOs know the importance of delivering strong trading whilst buyers’ eyes scrutinise virtually every KPI they can get their hands on, in the lead up to completion.
Winning hearts and minds
The huge diversity of approach from prospective investors in their treatment of management is fascinating. Financial investors, whether they are private equity, infrastructure, pension, family office or sovereign wealth funds, each have their own personalities, cultures, experiences and investment strategies which all play a part in shaping their approach to management. Fundamentally, the relative importance of management to the prospective funders and how much they value and want to build and develop that relationship becomes clear as the transaction progresses. This manifests itself both in the economic and legal terms that are offered to management, but also in how and the extent to which they interact with the team before, during and after signing.
The key priorities for management teams during a sale process are undoubtedly to firstly identify a new investor with good people who they can trust to be a supportive and reliable partner and secondly, to agree a good deal on the overall package of management terms. More often than not, the private equity firm who have invested the time and effort to build the strongest relationship with the management team before and during the sale process also come up with the most attractive terms.
Do Management know where they stand?
It is surprising how often we are seeing management’s equity position, long-term incentive arrangements and transaction bonuses not having been agreed and documented by the time exit approaches. This is more common when managers have joined part way through an investment and is not given the priority it deserves by investors who are happy to leave it for a while to see how things work out. Managers in the meantime immerse themselves fully in the business and often do not front up to the awkward conversation about their own position.
On a few occasions, this has caused some real issues for the vendor which have needed careful resolution during key stages of the transaction. These inevitable strains between owner and manager could have all been avoided, had the overall package been put to bed well ahead of embarking on a sale process. Increasingly, we are advising managers on an ad hoc basis in agreeing terms for a new role and strongly advise them to have this all signed-off in good time, so that they can focus fully on growing their business.
Management terms help to paint a picture
Whilst management teams rarely get overly agitated by the minutiae of the investment agreement, the potential investors’ position on various provisions often helps to build a picture of what they will be like to partner with.
Firstly, is the investor viewing the investment as a partnership with management or as an acquisition with management hired to run it? Evidence of the former include reinvested proceeds being on the same terms as the investor and management’s institutional strip sitting outside of leaver provisions.
Secondly, is the investor backing the existing team or anticipating future changes and additions? If the investor is requiring a significant level of sweet equity to be held in reserve, this may set some alarm bells ringing for the incumbent team. Likewise, lengthy vesting periods, capped vesting pre-exit and other draconian leaver provisions may all tell a story of how the investor could be viewing management.
Finally, management are often keen to understand the level of appetite that an investor has for supporting their acquisition strategy, particularly where this is a key component of their overall growth plan. Prescribing a specific quantum of follow-on funding to be available without sweet equity dilution is a powerful way for investors to demonstrate their conviction in backing management’s buy and build programme.
Will Management influence the outcome of the process?
It usually becomes apparent during the transaction how important each bidder believes the CEO to be to the business and to the outcome of the sale process. Investors’ attitude depends not only on their house style but also on their assessment of the deal dynamics:
- size of management’s existing equity holding and level of influence on board and shareholder decision-making;
- perceived importance of the team to current earnings and the business plan e.g. existing client relationships, new client acquisition, product development, strategy, M&A, staff recruitment and retention;
- the scale of the business and the reliance on key individuals; and
- the breadth, depth and length of service of the existing team.
We have seen a huge diversity of approaches to management on the 25 transactions that we have worked on in the year to date. At one end of the spectrum, we have advised on a transaction where a management team found out who their new owner was from the press release and incentives were not discussed until after signing. To the other end, where management had a significant equity stake and were so fundamental to the existing value and future growth of the business that who they wanted as their new investor became the key determinant in the ultimate outcome of the process.
Due diligence shouldn’t just be one-way
There have never been as many funds as there are today looking to invest in well positioned businesses run by strong management teams. This competitiveness is typically reflected both in headline price and also in the attractiveness of terms offered to management. Often, management teams under-estimate their ability during a sale process to influence the decision-making over the outcome of the process. If there’s little to choose from on headline price, vendors often appreciate that deliverability is improved if exclusivity is granted to a buyer who has the strong support of management.
Management teams with the most experience of different funds are typically those who see the benefit of ‘looking beyond the cheque’ and find the time to do their own due diligence on their potential funders. Key considerations are typically: Do they get our business and our sector? Do they listen to us? What contribution will they make? Will I enjoy working with them?
We encourage management teams to take their time with prospective buyers, to get to know the individuals, to not be shy of asking them plenty of questions and to reference them with other management teams they’ve backed in the past, including some with difficult trading histories post investment as well as those that have gone on to achieve great exits. Our experience clearly shows that the management teams who view it as a two-way process and invest time in understanding how the relationship will go, are that much more likely to find themselves with the right investor for the long term.