Business owners: pandemic shows the importance of “socialising” with potential investors

The pandemic has had as dramatic effect on owner-managed businesses as any other type of business, both positive and negative. With investors eagers to find a home for their capital – and many management teams keen to capture currently high valuations in many sectors – deal flow is strong.

But the pandemic has also highlighted the importance of getting the right fit with the right investor. As certain sectors have struggled in the wake of Covid-19 disruption, investors’ commitment has been tested as some businesses fail to meet targets or require fresh capital.

To better understand deal activity and trends as we enter the hoped-for rebound of 2021, Cazenove Capital invited Tim Thomas of Liberty, an independent corporate finance adviser to management teams in private equity transactions, to talk to a group of friends and colleagues about his observations of the current market.

These are some of his key points.

Advantageous, easy transactions are arising where owners “know their investor”

The pandemic and disruptive lockdowns brought an initial hiatus in deals, but this proved short-lived with M&A activity returning strongly in the summer of 2020 and continuing to be very strong.  For owner-managers, that’s also given them an opportunity to eye a range of potential investors and smooth the way to a “best-fit” transaction.

“What we’re seeing is that ‘no -process’ or a very limited process is becoming the new way of selling a business,” Tim Thomas explains.

“Where a business is well prepared and ‘socialised’ with potential buyers, the hope is that the eventual buyer will be ready to circumvent some of the traditional sale process. A management team is getting to know a range of potential investors well ahead. Fast-tracking is helpful, but it’s still crucial to select the best fit.”

Shaping the best transaction for you as an owner-manager

For the business owner, it remains as important as ever to identify what you want from any transaction well ahead.

Is cash extraction the priority? Or is it about support for future growth with you remaining in management?

Tim Thomas and Liberty have advised owners on scores of deals of different sizes and in different sectors, with a wide range of buyer and investor profiles. Different buyers typically bring different outcomes for the owner. Trade sales, for example – where the owner-manager sells to another firm in the sector – could suit business owners wanting a rapid exit, and the key terms of the deal are then likely to be any earn-out provisions, lock-ins, incentives and other legal agreements such as indemnities or warranties. A key outcome is the likely loss of control for the owner-manager.

A private equity transaction is different. “It’s much more of a journey, where working together and moving on through to another future transaction will be the aim,” Tim explains.

Here the financial considerations will include the amount of cash extracted and equity stake, as well as structuring the ownership of the new company. Incentives for the years ahead as well as provision for departure (on good terms or otherwise) will also be up for negotiation.

But there’s another dimension, which is the “chemistry” between owner-managers and their private equity counterparts as they work together growing the business.

“In our experience, when transactions go well, they bring together a new dynamic of business performance coupled with stronger team leadership. Performance is scrutinised but management is supported as it delivers the plan. If it all works out, it comes full circle – and you’re back at the start: what shape will the next deal take?”

Private equity in the age of Covid: true colours will out

The commonly held but largely inaccurate view is that private equity investors are generally reactive in their approach to portfolio company performance. The perception is that private equity stakeholders leave the management team alone if performance is strong and targets are being met. It’s only when the dashboard shows the numbers are going off plan that they act.  Tim Thomas feels that this is an unfair view:

“In practice, most are much more supportive than that, and stay fully engaged in good times and when things get more rocky,” Tim explains. “But it’s probably true that their behaviour during the tough times is most telling.

“What I’d expect to see from committed investors is a rational and reasonable approach. If there are structural changes in the marketplace, for instance, I’d expect them to understand. We have seen evidence of that during the pandemic in relation to hospitality and travel. Many businesses needed capital and in the majority of cases, private equity partners have taken a long-term view and stepped up.”

At a time when a lot of assets are chasing quality investment opportunities, private equity partners are finding ways to set themselves apart – potentially to the benefit of management. One way is by providing support in the form of “operational specialists”, especially useful during periods of difficulty.

“As private equity firms compete to differentiate themselves and maximise their returns, we are seeing an increasing breadth of value-add services which funds provide to their portfolio companies, including operational improvement, digital transformation and procurement services.  

Personal wealth planning post-transaction – “don’t rush”

The years and months ahead of any transaction are vital in identifying best-fit investors. But they are also an invaluable time in which to plan around the potential financial outcomes for the management team and their families.

Whatever shape the deal takes, there are likely to be tax implications and in due course further considerations about how money is to be used and invested.

Our experience at Cazenove Capital, built over generations working with owner-managers and family business-owners, is that decisions should be arrived at slowly and with care.

A major transaction is likely to be a consuming event. As the personal financial consequences for the individuals become clear, we’d always want to work at clients’ own pace. We’d actively encourage them to take time over key decisions, involving family members, and seeking to understand fully what they want to achieve with their wealth.