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Home / Insights / How to pursue private equity backing for acquisitive growth

How to pursue private equity backing for acquisitive growth

FOR BUYERS
How to pursue private equity backing for acquisitive growth

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With the UK economy struggling to recover from the effects on the population of the coronavirus pandemic and the on-again off-again lockdowns, it has been almost impossible for the majority of businesses to expand organically.

Early 2020 saw redundancies soar at the fastest pace and reach the highest level on record. Almost a third of the entire workforce was on the government-subsidised job protection scheme. And just as a recovery of sorts was dawning at the end of the year, a new strain of coronavirus plunged the country back into full lockdown.

One of the few viable ways for businesses to expand during the current crisis is through acquisitions. Acquiring businesses complementary to your own, providing you successfully integrate them, could put you in a strong position to benefit from a post-COVID economic resurgence.

The massive levels of uncertainty and distress plaguing many businesses mean that there are no shortage of acquisition targets, with many more open to a sale or available at a more favourable price than they would ordinarily be.

The likelihood is that your business may be feeling some of the strain of the pandemic too and, even if you aren’t in any imminent danger, you might not have the funds at your immediate disposal to go on an acquisition spree. With banks more focused on offering COVID-19 business emergency loans, this may also prove to be a more difficult way to source funding.

However, this doesn’t necessarily preclude you from building your business through acquisitions. Whilst there are a number of debt and equity funding avenues to explore - covered in some of our previous articles, today we are taking a closer look at private equity firms, which collectively have record levels of money to invest (or “dry powder”), with many having slowed or paused their activities during the pandemic.

If your business fits the profile private equity firms look for and can demonstrate the value it could deliver through an acquisitive growth model and, perhaps most importantly, if you can find a private equity firm that you feel you could build a mutually beneficial working relationship with, then private equity funding could be the perfect way for your business to hit the acquisition trail.

What do private equity firms look for?

It should be stated early on that private equity backing is not something that is going to be available to the majority of business owners. Private equity houses, on the whole, will have fairly stringent criteria for a business to meet before they will consider investing.

Here are some of the criteria that private equity firms might look for when investing in a business:

Financials:
Over £10m annual turnover
+ £2m EBITDA
Strong cash flow
Operating margins of at least 10 per cent
Gross margins of at least 20 per cent



Business:
Decent excess capacity in operations
Organic growth potential or clear acquisition strategy
Stable margins
Competitive advantage sustainable over the medium term
Strong recurring or repeat revenues
Good second tier management


While certain private equity companies may consider smaller businesses, they will likely be even more particular about the profile of the business they will invest in and will need to see clear evidence of growth potential, as well as a top drawer management team and evidence of corporate maturity.

If SME owners are seeking to grow through acquisitions, it would perhaps be more advisable to seek venture capital financing.

The types of investments private equity firms typically make range from straight or leveraged buyouts, minority stake acquisitions and public-to-private takeovers to flotations, refinancings or bolt-on acquisitions at firms within their existing portfolio.

A crucial element of any private equity deal is that they will more often than not be looking at making an exit from the business within 5-8 years. A private equity firm’s exit strategy is one of the core reasons why they will not ordinarily invest in a smaller business. When it comes time for them to exit the business, they are likely to be looking at selling on at a multiple of around 15-20x, more than double what a typical SME might achieve in a private trade sale.

Why should you seek private equity backing?

Getting the backing of a private equity firm to pursue acquisitions can be an excellent way for your business to rapidly expand, due to the scale of funds and strategic expertise that will be made available to you.

If you are able to attract backing from a private equity firm that trusts your judgement as the leader of your business and has the means and willingness to back your growth strategy, then you will be able to quickly and aggressively pursue acquisition opportunities.

Working with a private equity backer can also help you to avoid the scrutiny associated with pursuing more regulated forms of acquisition funding, such as business loans.

Private equity firms typically follow an ‘active ownership’ approach, whereby the PE firm works alongside company management to enhance the business value. The added financial backing and expertise should have a direct effect on the company’s profitability.

Working with a private equity firm will admittedly mean handing over a significant slice of the profits from your acquisitions, but their financial backing and expertise can mean that the profits you start bringing in could be significantly higher than what you’ve ordinarily seen.

Preparing to attract private equity funding

Potential backers will want to see that not only is your business successful, but that it is run smoothly and efficiently. Organised documentation, well-managed accounts, protected IP and sound processes will make a private equity firm’s due diligence process quicker and demonstrate a level of efficiency and professionalism in your business.

If you are raising money for acquisitions and your own business is not running efficiently, a private equity firm is unlikely to trust you to use their investment wisely.

Due diligence will be a crucial consideration for private equity firms and they will go over your business with a fine-tooth comb. Ensuring that they can get a quick, clear and accurate picture of your business will increase the likelihood of them investing and offer a solid foundation for your future working relationship.

Your acquisition strategy will be examined by the PE team and if you already have an acquisition target in your sights, the rationale for the purchase and financials of the deal will be closely analysed. If you are gunning to buy up distressed assets, it will be imperative to demonstrate your turnaround strategy is sound and without high risk.

It will also be important to have a solid management team in place that is experienced in your field and committed to the company and its plans for expansion.

Discussing private equity funding in the context of a management buyout, Edward Minton of private equity firm WestBridge explains how a good management team can be vital in attracting funding: “When we look to support a management buyout, we typically seek out companies with proven incumbent management teams that have been running the business for some time pre-deal.”

“Management teams come in all different forms but the successful ones tend to be highly entrepreneurial, well rounded, have deep networks within their niche markets and know exactly what they’re good at.”

“More importantly, they are self-aware individuals who understand their own weaknesses and are able to build a team around them with complimentary skills and capabilities to help drive value creation initiatives.”


You should also be prepared to invest significantly in your company, whether that is in IT, inventory, sales and marketing or product development. This will not only lay an important foundation for growth, it will show your commitment to spending the money necessary in the present to gain long-term success.

Of course, when courting a potential backer, you’ll also need a convincing and detailed business plan to get them on board. This should be a thorough, coherent, fully-costed growth plan covering several years, illustrating exactly how you plan to expand acquisitively and demonstrating that your business and your industry offers the scope for acquisitive scope.

Demonstrating your business’ scope for organic and acquisitive growth will be central to attracting investment. If a private equity firm sees that your business has a solid share in a niche market which offers the right environment to grow through acquisitions then you will be more likely to secure investment, as in the case of educational catering firm Innovate.

Discussing how his firm began working with Bridges Fund Management, Innovate Chairman Geoff Peppiatt says: “Bridges Fund Management, a specialist sustainable and impact investor, originally approached us directly to have an exploratory discussion. Bridges was attracted by the organic growth opportunity presented by the school catering market, as well as the clear scope for growth through acquisition (‘buy and build’). We stayed in touch and, following various meetings, both parties were keen to pursue the opportunity.”

Edward Minton also says that this is exactly the profile of business that WestBridge looks to invest in: “Private equity investors will look for a number of unique business characteristics. At WestBridge we look for profitable, niche market leaders or challengers with strong quality of earnings and a credible growth track record. In particular, we place value on characteristics such as strong trading visibility from long-term contracted revenue streams and established relationships with blue chip customers.”

“We also look for companies with strong and defensible positions in their niche markets, this being a definitive feature of other recent WestBridge II investments - one being a niche environmental consultancy focussing on the aquatic, marine and ornithology sectors and the other being the market leader in the supply and maintenance of automatic vehicle and train wash systems in the UK.”


Finally, it will be absolutely vital that your company (and not just you as the business owner) is ambitious, ready to change or adapt if necessary and that a hunger for growth is built into your company culture.

Along with a solid management team, ensuring that your key players are fully up to speed and working together towards a strategy of acquisitive growth will be crucial in not only attracting private equity backers but also in pursuing acquisitions successfully after this.

Negotiating with potential backers

Once your business is in the position where it’s attracting interest from potential private equity backers, it’s time to start thinking about how you will approach discussions in order to ensure the most successful outcome.

Firstly, before discussions turn to issues such as the financials, it is important that you focus on matters relating to the business and your vision for its expansion. Make sure you establish as soon as possible whether the firm you’re talking to is sympathetic to your plan for the business and shares your values.

Ensuring there is both a personal and professional chemistry between yourself and potential backers will lead to a more successful working relationship. After all, you’re going to be working with this firm for the next few years and a solid rapport will be vital to this.

From this point, discussions may become simpler, with the early positive talks perhaps helping you to more easily reach agreements on the financials of the deal. These issues won’t sort themselves, of course, but talks may go more smoothly over these tricky matters if you’ve started on the right foot.

When discussing financial matters, it’s important to be both firm and reasonable. You should of course stand your ground and try to secure the best deal for you, your business and your clients, but be open to making accommodations where necessary. After all, this firm is going to be bankrolling your expansion, so they will rightly expect to have some input in the process and to receive the dividends they are due from any future successes.

Throughout this process, having trusted, professional advisers to help guide you is absolutely crucial. A good adviser will not only be invaluable in conducting your due diligence and negotiating the terms of your deal with the private equity firm, but can also be vital in helping you establish a mutually beneficial working relationship.

Nick Gill, CEO of property furnishing and design supplier group David Phillips, explained how working with corporate finance advisory firm Clearwater International helped his company in their search for private equity investment:

“We worked with a corporate finance advisory house, Clearwater International, to canvass the market and draw up a long list of potential private equity houses that would be interested in investing in us. We went through a formal pitch process and created a shortlist of firms that were then invited to do due diligence and make investment proposals. We then moved through management presentations, with the firm doing some market analysis through to negotiation of documentation and close.”

“We worked with a team that had good experience of the PE world which is key. Beyond that, you need people who understand the process; are familiar with the PE houses’ quirks, idiosyncrasies and defining slants and can also explain clearly to the wider management team what the investors are looking for.”


From 840 sites to over 7,000 in less than two years – Premier Park and Sovereign Capital

Premier Park is one of the UK’s leading providers of professional, automated car park management solutions, quickly growing from its founding in 2005 to become an operator with a national footprint. The business installs and operates Automatic Number Plate Recognition (ANPR) cameras for SME and corporate customer car parks, as well as payment management and patrol solutions.

In 2019, the firm decided to partner with private equity firm Sovereign Capital in order to gain management expertise and the funding to target strategic acquisitions and take the business to its next phase of growth. Since gaining the backing of Sovereign, Premier Park has undertaken three strategic acquisitions, including its recent takeover of Park Watch, and has grown from operating around 840 UK sites, to more than 7,000.

Premier Park CEO Paul Dawson explains the benefits of pursuing acquisitions with Sovereign Capital: “We operate in an evolving market where our clients are constantly looking for an improved service and greater demand on valuable data insights (…) With Sovereign’s investment and help in identifying opportunities for strategic acquisition, and then supporting each deal process, we are well placed to further develop the Group, broadening our service proposition and continuing to deliver the efficiency, innovation and customer satisfaction this business is recognised for.”


What impact have recent events had on private equity?


COVID-19

As the global economy continues to be decimated by the COVID-19 pandemic, one segment that has rebounded relatively strongly and seemingly adapted to operating around (and even benefiting from) the virus is M&A.

For that reason, for firms looking to rapidly expand in the here and now rather than simply waiting out the crisis, strategic acquisitions may be the best bet. However, in the likely event that COVID-19 has had an impact on your cash flow and reserves, then using it may not be feasible or advisable for you to use your own cash or seek acquisition loans in order to finance this.

Private equity, then, could offer the ideal solution. What’s more, private equity houses are thought to be currently sitting on record levels of cash after cutting investment activity during much of 2020.

According to one report, European private equity houses currently have around €76.7 billion in dry powder, while Deloitte recently put the figure in the USA at more than $1.5 trillion. These numbers indicate the sheer scale of funds private equity firms have at their disposal and many are predicting that they will look to use it in 2021.

Of course, COVID-19 has also led to massive levels of business distress among companies that, at most other times, would be totally viable. Looking just at the UK, the ONS estimates that over 30 per cent of UK businesses currently have, at most, three months of cash reserves remaining. In the short term, this means a huge amount of distressed acquisition opportunities.

According to Robert Olsen of Deloitte: “We see significant opportunity for private equity because of all the dry powder they have accumulated, plus all the stressed and distressed funds that have been raised—all of which will be ready to pounce.”

“We further expect great M&A activity coming out of COVID as it will be necessary for many companies to find liquidity options if they don't have a robust business going forward or in a sector that remains in favour.”

So, if your company is already solid, you’re looking to grow and you’re in an industry with plentiful acquisition opportunities, then there may be scope to partner up with a private equity backer with whom you share a cohesive acquisition strategy and vision for growth.

Brexit

Away from COVID-19, there’s no escaping the other elephant that has dominated the room for the last five years. We are of course talking about Brexit and, as always, there remains considerable uncertainty around how the UK’s protracted exit from the EU will play out.

Despite this perpetual uncertainty, in the years since the Brexit vote, private equity investment has proven resilient. According to CMBOR data, UK buyout value saw a sharp drop in the six months immediately following the June 2016 vote, before doubling year-on-year in 2017.

However, with the UK now out of the EU, it seems likely that cross-border deals with companies based in the EU will be subject to greater scrutiny. With UK-only deals now regulated by the Competition and Markets Authority rather than the European Commission, though, there is some hope that deals between UK companies could become easier.

Ross Allardice of Dechert summarises the current uncertainty: "It will be interesting to see what the UK does, as that will pave the way to see how deals are going to be commonly done in the UK. The whole point about getting Brexit done was to deregulate and to lessen the red tape. What will happen in practice is yet to be seen."

In the post-COVID landscape, expanding through acquisitions is the most viable way for companies that have survived the crisis to scale up and grow. There are going to be no shortage of promising businesses in need of investment in order to stay afloat and who will be more than open to an acquisition.

The sheer scale of business distress and the likelihood of a post-COVID economic resurgence mean that an acquisitive growth model has probably never been more appropriate or advisable than it is now.

With huge levels of dry powder just waiting to be deployed, private equity houses are the perfect facilitators for large-scale, rapid, acquisitive growth. For companies able to secure a solid, aggressive working relationship with a private equity backer, the current climate will offer rich pickings.


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