Personal chemistry is important in private equity deals
Peter McLintock (left), partner at Mills & Reeve and Richard Thomas (right) of Palatine Capital, say that building a relationship with management teams in advance of any potential deal also helps build trust between the target and investor.
We understand there is a substantial amount of cash available for private equity investment?
There is a significant amount of money looking for a home. This is, in certain circumstances, leading to high multiples being paid and also the development of other forms of finance, such as debt funds, in an effort for large fund managers to deploy money in different ways, albeit, accepting a lower return. There has been a banking up of funds in recent times due to a lower volume of deals available to PE houses. This can be attributed to an active trade to trade M&A scene where PE deals are beaten to market by trade buyers because they see synergies and cost savings.
If there are very few potential targets, how do PE firms compete for what is available and where next?
Private Equity (PE) firms are competing more and more on relationship and the value add they can bring. Being creative with deal structuring, demonstrating a deep understanding of the target business and highlighting the potential areas the PE house can add value to the management team’s strategy is key. There is also a drive towards securing off market deals away from competitive processes. Building a relationship with management teams in advance of any potential deal also helps build trust between the target and investor. There are still a number of sellers who do not wish to see their life’s work go to the competition and can still command good multiples by selling it to a financial institution, complete with management. PE houses are less willing to be dragged through multiple party auctions and prefer to develop their own relationships as the main driver for winning a mandate which comes down to personal chemistry. While it will not bridge a large differential in price, it can sometimes be the element that tips the balance. PE are also sellers which means a lot of the houses are looking to place their portfolio into the market while waiting for the right asset to come along to buy.
If valuations are on the high side, what does this mean for the trust industry?
Within reason, the entry price is only one part of the equation. Paying a high entry price dictates that the buyer has to be pretty confident of a large multiple of money return within an acceptable exit window, so it just makes it more expensive to play. It may also mean that the fund needs to be bigger.
Tell us about secondary deals. Is it just financial engineering?
Not necessarily. Often businesses will get to the stage where they need a different PE house to support the next stage of growth. Some houses will be better positioned to support expansion overseas or to provide further investment for growth. Sometimes the business can outgrow the team and it needs to be supplemented so it takes on the shape of a secondary buy-in management buy-out (BIMBO).
How would a bubble hurt the market? Is it simply inability to sell?
The effect of multiples continuing to go up could hurt when it is difficult to move the assets along at acceptable internal rate of return (IRRs), and money raised on historic returns do not then meet the stated hurdle rates of return. With a lack of cheap leverage this eats into the PE fund itself, so the number of investments possible reduces if assets are acquired for rich prices.
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