Private equity and acquisition finance are the two principal forms of finance which are combined to finance buy-out transactions. Private equity is the higher risk, higher return, share capital or equity-based element provided by equity houses (venture capitalists and other private equity institutions). Institutional Equity takes the form of ordinary shares and quasi-equity in the form of either redeemable preference share or subordinated loan capital.
Private equity funds more closely resemble venture capital firms in that they invest directly in companies, primarily by purchasing private companies, although they sometimes seek to acquire controlling interest in publicly traded companies through stock purchases. They frequently use leveraged buyouts to acquire financially distressed companies. Unlike hedge funds focused on short-term profits, private equity funds are focused on the long-term potential of the portfolio of companies they hold an interest in or acquire. Once they acquire or control interest in a company, private equity funds look to improve the company through management changes, streamlining operations or expansion, with the eventual goal of selling the company for a profit, either privately or through an initial public offering in a stock market. To achieve their aims, private equity funds usually have, in addition to the fund manager, a group of corporate experts who can be assigned to manage the acquired companies. The very nature of their investments requires their more long-term focus, looking for profits on investments to mature in a few years
Private equity has the following features: It is non-recourse; as seller, equity houses will not give waranties or indemnities except for exceptional circumstances. Private equity has short to medium term horizon. Most private equity is invested via partnerships of a limited duration generally up to 10 years. Investors have purely passive role so they are limited partners, they have limited liability and they invest on the basis of the track record and expertise of the sponsor. Financial sponsor focus on providing a good return to investors (to raise further monies for next refund) Success of the investment is measured in Internal Rate of Return (IRR).
The actual level of equity will be set by reference to the return on its investment which the institutional investor would seek to make and exit at a pre-determined point in the future and at a pre-determined financial level. This return is called the internal rate of return (or IRR) to the institutional investor.
Successful exits are the basic reason why equity houses are in the business of facilitating buy-outs. . The pools of Money managed required capital gains and this means exit. The two principal exist which the institutional investor and management team will contemplate are a flotation and a trade sale. A sale to new buy-out team may also be a possibility, although these are quite rare. If a flotation or trade sale(or secondary buy-out) does not ocur the institutional investor will, if the business perform well, usually be able to exit, to some extent, through redemption of the quasi-equity invested by it.
Where the purchaser of a business is financing aquisition by a significant amount of debt, which generally means that its level of debt exceeds the amount of its equity, the acquisition is said to be highly leveraged. In the case of a buy-out a special purpose vehicle will be set up to make the purchase and the amount of debt taken on by this purchaser a significant portion of the total purchase price, at least 50%. This is why buy-outs are often described as leveraged buy-outs or LBOs.
The process for nearly all buy-outs will comprise a number of common stages such as the initial sale process, raising finance, reaching agreement in principle with the vendor, due diligence and documentation to completion and the approach of the vendor to the sale process. And finally the exit step is taken to realise the investment.
Firstly, the vendor may initiate the sale process for strategic reasons or a consequence of the trading results of the target business. This is the initial sale process for buy-outs which are not true MBO/MBI. The vendor will distribute the information memorandum to one or more identified potential buyers. This may be the first stage of an auction process. Alternatively, a management team (alone or with an equity house already on side) may initiate the sale process having determined that an MBO or MBI is something which they would wish to and are able to pursue. In anticipation of the approaches which will be made to equity houses and acquisition finance providers, the management team will produce a detailed business plan for the next five years
Once there is agreement in principle between the prospective purchaser and the vendor for the buy-out and conditional offers of finance are in place to finance the buy-out, the due diligence process will commence in earnest. After that, the acquisition financiers which have been mandated to arrange and provide the acquisition finance debt will appoints lawyer to provide documents to complete transaction after signing. At completion of the acquisition the formalities necessary for perfecting the transfer of the shares in the target to the purchaser will be effected. Completion having occured, the target will be owned by newco.
Ultimately the management team and the institutional investor will be aiming to realise their investment in the business. Such realisations are generally described as exits. The principal exits which the parties would favour are sale of the group or business either to a trade buyer or to a new buy-out team and flotation of the group(IPO). Debt providers are satisfied by repayment of principal + interests when due and capital providers are satisfied by recovering their investment + dividens & capital growth.
Atty Gonenc Yay, LL.M