What terms are currently being offered to management teams by private equity investors and how have these trended over time? Do they differ depending upon deal size or deal type?
Using data collected from private equity proposals to management teams covering the period from 2006 to the end of 2015, we have analysed some of the key metrics and trends.
The data over this period comprises over 100 different proposals put to management teams from some 70+ different private equity investors, ranging from lower mid-market primary management buy-outs to large cap tertiary auctions. While the businesses are UK or European based, they are from all sectors of the economy with private equity investors from the UK, US and Europe.
In this article we look at base sweet equity allocations that have been proposed to management teams and how they differ across deal size, type of buyout and trends over the last three years.
Key Findings - Base Sweet Equity
Across all data the average base sweet equity made available to management teams was 19.1%, with deals under £100m providing higher allocations than those in the above £250m range.
There was no difference between the average base sweet equity allocation across primary versus secondary (or tertiary) buyouts.
What do these percentages mean for management teams and the potential financial outcomes on an eventual exit?
In the last three years the average MoM, assuming a 4-year exit horizon across all deal sizes, that a £1 investment in sweet equity was projected to achieve was over 150x with the minimum 38x and the maximum over 500x illustrating the potential returns that sweet equity can achieve.
This equates to an average sweet equity allocation of £28.4m with larger deals offering larger potential returns, £46.6m, but typically spread across a wider team.
The average base sweet equity actually agreed by the winning bidders in auctions in the three years to 31st December 2015 was 19.9% regardless of the EBITDA multiple paid for the business, with competition and management leverage driving base sweet equity allocations slightly above the market average.
There are a number of “wealth warnings” with base sweet equity as a stand-alone economic as it is only one part of the financial equation for management teams:
- Institutional loan note yields put in place a hurdle before the sweet equity is “in the money” and therefore a relatively high base sweet equity incentive allied with a relatively high loan note yield will only be appropriate in certain circumstances
- Ratchets are more commonly being used to “top up” base sweet equity and incentivise management above agreed money multiple hurdles, providing additional sweet equity returns
- The actual base sweet equity incentive available to the existing management team may be diluted by allocations to others, e.g. a chairman (and other non-execs) and reserved equity for future hires
The whole economic package needs to be considered and modelled out for each transaction and for each management team as all businesses and management teams have different risk/reward profiles and one size does not fit all.