Salim Somjee, Head of Private Equity at Cripps Pemberton Greenish talks to SME Today about why Private Equity-backed businesses shouldn’t shy away from Mergers & Acquisitions in new sectors…
Private equity firms have been key in driving Mergers & Acquisitions activity over the last 10 years, for various reasons;
- they have been able to offer healthy multiples
- they quite often come to the table as cash buyers
While the process when selling to trade is involved, a sale to private equity can be even more complex, but that is not, in itself, a bad thing.
Private Equity transactions are more complex
There are more layers of documentation in a sale to PE compared to a trade sale. This is because the management team essentially partners with the private equity firm to co-own, manage and grow the business together. Some sellers and management teams don’t appreciate at the outset of a PE process that there is another layer of compliance that PE firms need to work through before they can complete an acquisition. This may result in questions being asked whether or not it is easier to sell to trade than to PE and whether or not PE genuinely understands a particular sector or business when entering the transaction process.
One size doesn’t fit all
A sale process needs to be very carefully managed. Advisers need to be chosen carefully, as do the buyers. Whether someone sells to trade or PE, they will either have ongoing involvement or some of their purchase price will be linked to future performance; finding the right buyer to partner with is crucial and takes time. Trust, personal dynamics and understanding of the target business and the sector it operates in are crucial considerations.
Different PE firms have different approaches to sectors; some firms are sector specific and some are not. One thing is consistent between both approaches; PE would not invest if it did not have a good understanding of the sector in question. Good corporate finance advisers, accountants and lawyers will be able to help find the right PE firms to talk to.
All transactions are about balancing risk
The question of understanding a sector can be closely linked to managing the risks associated with an investment. PE firms are entrusted with client money invested in their funds, for the purpose of investing in businesses to sell them on and generate a return. PE will, understandably, want to manage operational, reputational and financial risk.
Ethical investing is a real thing and not a soundbite
Managing reputational risk is not window dressing. Generally speaking, people with bad reputations are not the most ethical people! Ethics is about following the rules (to the letter and in spirit) and trying to do the right thing.
Rules are rules
PE firms are FCA regulated; if they are struck off the register, they lose their ability to conduct their business. Much like law firms, PE firms will be subject to a lot of regulatory obligations relating to “know your client”, “source of funds” and ensuring that transactions are not entered in to for the purpose of avoiding tax. Further, the target business that is the subject of the transaction will need to be legally compliant as regards its operations and structure. As an example, a common area of risk sits around data protection. A software business that licences its software to the education sector or to HR teams will perhaps have more data protection due diligence carried out on it to ensure it is fully GDPR compliant; breaches could lead to substantial fines and reputational damage. These issues are not barriers to doing a deal, as the regulatory and legal risk can be largely addressed with a thorough due diligence exercise and appropriate contractual protection, which would still be needed on a sale to trade.
There is a genuine desire to invest ethically
While PE wants to be seen to be doing the right thing, it also wants to do the right thing. The concept of ESG (environmental, social and corporate governance) is not new, but there is much more focus on it. Many organisations have expressed a desire to ensure that their investment (whether it is internal or external) is sustainable and responsible. With that in mind, some PE firms will avoid certain more “controversial” sectors. When individuals make investments, they often specify that their funds are not invested in certain sectors (tobacco being a common one). PE is no different. Commercial and legal due diligence will look at areas such as modern slavery, anti-bribery/corruption, client/customer base, supplier base, compliance with sanctions and the “integrity” of jurisdictions with which the target business trades. All these are areas that can cause damage from a regulatory and legal perspective, as well as harm the reputation of the target business and its investors. These issues apply whether or not the target business is sold to trade or PE.
A lot of the responsibility for “policing” wrongdoing and illegality has been placed on to industry and professional advisers, so it is logical that this will impact more on transaction DD and result in more thorough exercises being carried out. Yes, PE buyers will likely go in to more detail than trade buyers, but then they will have more to lose if things go wrong, given the reputational damage and potential loss of future investors on which PE relies. That is not to say that trade buyers are not concerned with the rules and regulations, but the risks are different.
There will be sectors that PE will be less interested in, or certain businesses which, for various reasons, PE will not want to invest in, but there are many others which it will, as evidenced over the last 10 years. The article started off by saying that PE has driven M&A activity in the last 10 years and there is no reason to suggest that it won’t for the next 10 years. It’s just not for everyone.
Author: Salim Somjee, Head of Private Equity, Cripps Pemberton Greenish