After a hesitant stop-start as the pandemic impacted the UK economy, deal appetite for private equity backed management buyouts quickly sprang back into life last summer and has continued to grow.
Of course, accepting private equity investment in many cases means introducing significant third-party debt to the balance sheet, often for the first time in the company’s life and usually at, or in the twelve months following, investment. Using leverage to drive deal returns for sponsor and management shareholders alike is a well-trodden path, but the shape and size of those debt packages is constantly evolving.
As in 2008, the dislocation of credit markets in the wake of the pandemic has once again reshaped borrower options for buyout leverage, and nowhere more so than in the £1-5m EBITDA lower mid-market segment. Traditionally still largely the domain of mainstream lenders, the avalanche of CBILS applications swamped bank lending teams in 2020, leaving access strictly for existing customers only.
Private credit, as it has done for nearly a decade now in the larger deals market, stepped into the gap with many funds reducing their minimum business size thresholds to be relevant in the lower mid-market. Offering reduced amortisation, longer maturities, higher leverage and most importantly over the last 12 months, strong conviction with faster deal execution, the swing to private credit in this segment was striking in 2020. However, as the pressure of government loan schemes diminishes there are signs that the Banks are returning to the new deals track in 2021, a recent example being the completion of Horizon Capital’s MBO of The Marketing Practice in April.
For a long time the staple of conservative SME lending, the pandemic has also allowed asset-based lending (ABL) to demonstrate its effectiveness in the racier world of leverage buyout financing. Where increased uncertainty has dampened the appetite of cash-flow lenders for certain sectors, releasing funding against the secure value of invoices, stock and PPE has enabled deals to continue to be done.
Layering a reduced strip of cash-flow lending behind a bigger ABL line, either from the same lender or another, is also providing an effective buyout financing structure when the asset base runs short. Such a strategy was used effectively by HMT in the MBO ofWheelwright Ltd, a leading UK wheels and automotive aftermarket wholesaler supported by Arbuthnot Commercial ABL and Caple International.
Despite this desire to do deals, surely a recession of the likes not seen for 314 years would show the high-water mark for leverage appetite in the buyout market? Not so this time around as government support and low interest rates have suppressed credit losses, which alongside deep reserves of fund liquidity is driving the continued confidence to lend. However as inflationary pressures grow and fiscal support is withdrawn, we may well see interest rates rise and delayed credit stress begin to materialise this year, reshaping the credit cycle yet again.
With more optionality than ever for buyout financing, ensuring the correct approach to debt structuring at the outset is vital for management to deliver the growth plan once the dust has settled on their newly minted private equity partnership.
If you’re contemplating an MBO this year and would like to discuss financing options, please do get in touch with our team on 01491 579740.
After a hesitant stop-start as the pandemic impacted the UK economy, deal appetite for private equity backed management buyouts quickly sprang back into life last summer and has continued to grow.
Of course, accepting private equity investment in many cases means introducing significant third-party debt to the balance sheet, often for the first time in the company’s life and usually at, or in the twelve months following, investment. Using leverage to drive deal returns for sponsor and management shareholders alike is a well-trodden path, but the shape and size of those debt packages is constantly evolving.
As in 2008, the dislocation of credit markets in the wake of the pandemic has once again reshaped borrower options for buyout leverage, and nowhere more so than in the £1-5m EBITDA lower mid-market segment. Traditionally still largely the domain of mainstream lenders, the avalanche of CBILS applications swamped bank lending teams in 2020, leaving access strictly for existing customers only.
Private credit, as it has done for nearly a decade now in the larger deals market, stepped into the gap with many funds reducing their minimum business size thresholds to be relevant in the lower mid-market. Offering reduced amortisation, longer maturities, higher leverage and most importantly over the last 12 months, strong conviction with faster deal execution, the swing to private credit in this segment was striking in 2020. However, as the pressure of government loan schemes diminishes there are signs that the Banks are returning to the new deals track in 2021, a recent example being the completion of Horizon Capital’s MBO of The Marketing Practice in April.
For a long time the staple of conservative SME lending, the pandemic has also allowed asset-based lending (ABL) to demonstrate its effectiveness in the racier world of leverage buyout financing. Where increased uncertainty has dampened the appetite of cash-flow lenders for certain sectors, releasing funding against the secure value of invoices, stock and PPE has enabled deals to continue to be done.
Layering a reduced strip of cash-flow lending behind a bigger ABL line, either from the same lender or another, is also providing an effective buyout financing structure when the asset base runs short. Such a strategy was used effectively by HMT in the MBO ofWheelwright Ltd, a leading UK wheels and automotive aftermarket wholesaler supported by Arbuthnot Commercial ABL and Caple International.
Despite this desire to do deals, surely a recession of the likes not seen for 314 years would show the high-water mark for leverage appetite in the buyout market? Not so this time around as government support and low interest rates have suppressed credit losses, which alongside deep reserves of fund liquidity is driving the continued confidence to lend. However as inflationary pressures grow and fiscal support is withdrawn, we may well see interest rates rise and delayed credit stress begin to materialise this year, reshaping the credit cycle yet again.
With more optionality than ever for buyout financing, ensuring the correct approach to debt structuring at the outset is vital for management to deliver the growth plan once the dust has settled on their newly minted private equity partnership.
If you’re contemplating an MBO this year and would like to discuss financing options, please do get in touch with our team on 01491 579740.
The acquisition price for a business is typically agreed on a “debt and cash free basis”, whereby the headline price or “Enterprise Value” is adjusted upwards or downwards for net cash or net debt in the business. This adjustment can have a significant impact on the final acquisition price.
Generally there are two widely accepted mechanisms for adjusting the Enterprise Value: “Completion Accounts” and “Locked Box”. The mechanism is usually agreed as part of the initial negotiations between the buyer and seller.
A Locked Box mechanism has the advantage of setting the final acquisition price prior to completion and, whilst there may be significant additional costs with professional advisors in agreeing Completion Accounts, it can provide the Buyer will added protection. Whilst there has been a trend towards using a Locked Box in recent years, with almost 90% of deals at HMT using a Locked Box pre COVID-19, transactions have increasingly moved towards using Completion Accounts over the last year.
A key factor in the shift is considered to be the extra certainty given by the completion accounts mechanism in the COVID climate, but how long this shift is maintained is open to debate.
Completion Accounts are typically considered to be more favourable to the buyer, with the economic risk of the target only transferring to the buyer upon completion of a transaction, which buyers consider particularly important during times of uncertainty, such as the pandemic situation over the last year. .
Furthermore, Completion Accounts provide additional comfort to a buyer when there is a significant amount of time between the date at which financial due diligence is being performed and the expected completion date, as has been the case on a number of recent deals at HMT which paused during the pandemic..
On the other hand, a Locked Box mechanism is seen to be more favourable to the seller, as the buyer ultimately taking on the risk of how the target performs between the locked box date and completion, with the seller typically receiving an agreed “profit ticker” during this period. In addition, sellers tend to prefer a locked box mechanism, as it provides them with more certainty with locked box accounts being agreed in advance of a transaction completing.
A fundamental difference between the two mechanisms is that the Locked Box is negotiated prior to completion meaning if one party does not like the outcome, they ultimately have the ability to walk away from the deal. With this knowledge, a reasonable outcome for both parties is usually negotiated.
Alternatively, Completion Accounts are agreed post completion. As such, if there are areas of disagreement, a formal legal process will have to be followed to determine the final acquisition price. This carries a risk of parties potentially falling out. Where the seller remains key to the business going forward (i.e in an on-going management role), this is not a positive way to start a new relationship.
In summary, the completion mechanism used is typically determined by the experience and negotiating power of both the buyer and seller, and hence it is more important than ever that both buyers and sellers consider the impact of completion mechanisms at the start of each transaction. A thorough financial due diligence process should mitigate the extra protection provided to the Buyer by way of Completion Accounts and so should be factored into the decision on choice of mechanisms.
Our Transaction Services team are ready to help you navigate through any stage of a transaction process you are contemplating, so please do get in touch with us on 01491 579740 or alternatively on 07966 665 126.
The acquisition price for a business is typically agreed on a “debt and cash free basis”, whereby the headline price or “Enterprise Value” is adjusted upwards or downwards for net cash or net debt in the business. This adjustment can have a significant impact on the final acquisition price.
Generally there are two widely accepted mechanisms for adjusting the Enterprise Value: “Completion Accounts” and “Locked Box”. The mechanism is usually agreed as part of the initial negotiations between the buyer and seller.
A Locked Box mechanism has the advantage of setting the final acquisition price prior to completion and, whilst there may be significant additional costs with professional advisors in agreeing Completion Accounts, it can provide the Buyer will added protection. Whilst there has been a trend towards using a Locked Box in recent years, with almost 90% of deals at HMT using a Locked Box pre COVID-19, transactions have increasingly moved towards using Completion Accounts over the last year.
A key factor in the shift is considered to be the extra certainty given by the completion accounts mechanism in the COVID climate, but how long this shift is maintained is open to debate.
Completion Accounts are typically considered to be more favourable to the buyer, with the economic risk of the target only transferring to the buyer upon completion of a transaction, which buyers consider particularly important during times of uncertainty, such as the pandemic situation over the last year. .
Furthermore, Completion Accounts provide additional comfort to a buyer when there is a significant amount of time between the date at which financial due diligence is being performed and the expected completion date, as has been the case on a number of recent deals at HMT which paused during the pandemic..
On the other hand, a Locked Box mechanism is seen to be more favourable to the seller, as the buyer ultimately taking on the risk of how the target performs between the locked box date and completion, with the seller typically receiving an agreed “profit ticker” during this period. In addition, sellers tend to prefer a locked box mechanism, as it provides them with more certainty with locked box accounts being agreed in advance of a transaction completing.
A fundamental difference between the two mechanisms is that the Locked Box is negotiated prior to completion meaning if one party does not like the outcome, they ultimately have the ability to walk away from the deal. With this knowledge, a reasonable outcome for both parties is usually negotiated.
Alternatively, Completion Accounts are agreed post completion. As such, if there are areas of disagreement, a formal legal process will have to be followed to determine the final acquisition price. This carries a risk of parties potentially falling out. Where the seller remains key to the business going forward (i.e in an on-going management role), this is not a positive way to start a new relationship.
In summary, the completion mechanism used is typically determined by the experience and negotiating power of both the buyer and seller, and hence it is more important than ever that both buyers and sellers consider the impact of completion mechanisms at the start of each transaction. A thorough financial due diligence process should mitigate the extra protection provided to the Buyer by way of Completion Accounts and so should be factored into the decision on choice of mechanisms.
Our Transaction Services team are ready to help you navigate through any stage of a transaction process you are contemplating, so please do get in touch with us on 01491 579740 or alternatively on 07966 665 126.
