When considering launching a deal process, one of the first decisions to make to make is what kind of buyer or investor you and your business would be most suited to. There are various factors that will affect this and one of the key roles of your adviser is to help you identify the most appropriate partner.
A key distinction to make is whether to pursue a trade sale or a sale / fundraise with a private equity firm. This article seeks to explain four key differences between each.
1. Buyer and investor motivations
For trade buyers, there are a variety of reasons they might seek to make an acquisition. There could be a strong strategic rationale such as gaining access to new service offerings, specific talent or capabilities, access to new clients or expanding into new geographies. They will generally be prepared to pay a premium for this to save the time and monetary expense, as well as the risk, of developing this in house. Alternatively, a trade buyer might already have similar capabilities and are seeking to achieve market growth and benefit from economies of sale. This can lead to what is known as multiple arbitrage, where due to its superior scale, a buyer can immediately benefit from a higher EBITDA multiple than they paid to acquire the target, creating instant value.
For private equity buyers and investors, the motivations are based on financial returns. Funds generally have target returns for their investors and therefore seek to achieve a minimum level of return within a specific timeframe. This means that post-acquisition they will seek to grow the business before a secondary sale (at a higher valuation), generally within 3—5 years. A common method of achieving this growth can be through a series of ‘bolt-on’ acquisitions (complementary companies acquired by the company with the support of the private equity firm), allowing a business to grow at a faster rate than it would have organically. Alternatively, the private equity buyer / investor might provide the additional capital required to grow organically through launching new services or expanding into new geographies.
2. Deal structure
A trade buyer will generally seek to purchase 100% of the shares at completion, allowing a full exit for the existing shareholders. In the media and technology sectors, there will generally then be an element of deferred consideration or an ‘earn-out’, , whereby additional consideration will be due based on the profits achieved in a defined period post-acquisition (generally 2-3 years). Some buyers may prefer a structure in which they acquire a controlling stake (but not 100%) at completion and buy-out the remaining stake over a defined period post-deal. This is usually linked to the profits across the period so provides a very similar overall deal outcome to a full sale and earn-out.
Private equity deal structures can vary hugely deal by deal. Each fund will have their own thesis and structure deals accordingly, with some having a preference for a minority stake and others seeking to take a majority shareholding. One common factor is that they will seek to incentivise the management team through the use of a “sweet equity” pot, allowing key management to participate in the growth in value of the business ahead of a secondary deal. In a minority deal, the existing shareholders will generally roll over their remaining equity interest, either through retaining their existing equity or through issuing loan notes or preference shares. As a result, the overall deal value will have significant upside should the business continue to grow and improve its valuation.
Another transaction type that we regularly advise on, is sale to a private equity backed group. These transactions will generally involve an up-front purchase of 100% of the business and an earn-out period, as with a normal trade sale. However, the consideration paid will likely involve a mix of cash and equity in the buyer group, providing reduced liquidity but the opportunity to participate in the upside potential of the buyer group’s growth, which will only be realised on the eventual sale of the buyer group.
3. Valuation
As private equity firms are generally driven by financial returns, it is likely that they will all value a business using a similar method and therefore arrive at similar valuations. However, trade buyers will likely have different reasons as to why they might want to purchase the business and therefore differ in how they approach valuation. Where the business offers strong strategic advantages, they might be prepared to offer a premium compared to other buyers. Analysis of deal multiples from the WY M&A tracker indicates that strategic buyers pay marginally better than private equity, with deal multiples on average 8.3% higher.
4. Management and seller ongoing involvement
As most trade sales with the media and technology sectors involve an earn-out period, existing management teams are incentivised to stay on for this period to maximise their potential deal value. Buyers seek this to aid the integration of the seller company into the buyer group and ensure a clean transition. However, once the earn-out period has been completed, the sellers are generally afforded a clean exit.
Private equity investors often view their investments as investments in the personnel in a business as much as the service / product itself, and therefore the majority of deals rely on a strong management team remaining in place. Existing management shareholders will likely retain a portion of their shareholding post deal in order to align their incentives with the private equity investors and continue to drive business growth before a secondary exit. It is also likely that other key management personnel who were not previously shareholders will be granted sweet equity in the company.
Every business is different and therefore there is no right or wrong or wrong approach during a deal process. Founders will need to carefully consider their motivations for a deal before deciding on the best approach to take. Appointing an adviser will help identify and explain the potential implications of each deal, allowing you to be best informed and make the right decision for you and your business, ensuring a successful outcome.
If you have any questions, or would like to chat about your upcoming M&A plans, please get in touch at hello@wypartners.com.
Contributors
Ollie Smith
Manager