Rolling into private equity-backed strategic buyer capital structures: Where are the bear traps?
The prospect of rollover equity is an enticing one for founders and management teams. Reinvesting in a newly formed joint venture represents an attractive opportunity to make a second return on an investment.
However, it is essential that you avoid the potential traps that lie in wait. With early alignment, clear communication and transparency, they can be avoided – but let’s look in detail at the potential risks strewn across your path at this point.
Valuation of the buyer
This is the most important consideration for any business leadership team that is invited to roll over by a new private-equity backed buyer. You know everything about the valuation of your business, but what about the other side of the deal?
You are being asked to enter a private equity-backed buyer structure and, by definition, you do not know as much about that business as you do about your own.
The company in question will have had a valuation placed on it when it entered into its original PE-backed arrangement, but how do you assess the updated valuation now being applied? How much evidence do you have to support the updated valuation?
It is essential that you ensure you are not buying into an inflated valuation, and that you get complete clarity over the structure implied by that valuation. You are moving from a position of knowing everything about your business to one where you have less clarity.
The solution is to request an open-book approach from your buyer. With all the right information, you will be able to understand their business, its strategy and cash flow, so that you gain an early insight into what a joint business plan will look like.
Percentage of rollover equity
If your company is being bought by a private equity investor, you might be expected to reinvest up to half of that in the new entity. However, if you are being bought by a private-equity backed company, our view is that you should not be expected to go as high as 50 per cent. Your lack of knowledge of the company in question adds to the risk level.
Ordinarily, we would suggest a reinvestment of up to 25 per cent of your holding – but even at that level, you should still seek the reassurance and clarity with regard to the areas discussed above.
Other potential pitfalls
Apart from the major traps already discussed, there are several other areas around which you should seek as much clarity as possible before proceeding with a rollover equity deal. They include:
- Funding for growth: What are the shared expectations of the level of capital investment in the new entity?
- Governance: Find out as much as possible about the proposed day-to-day operations at all levels.
- Future dilution risk: Are there any plans to issue further shares that may effectively reduce your percentage holding in the company?
- Exit timings and strategy: If you are being taken over by a PE-backed company, what is the expected or planned timeline to exit? If they have already been on this journey for three years, for instance, you may have only two years to wait before an exit, and the rewards that come with it.
If you are contemplating rolling into a new PE-backed structure, you need all the expert advice available. Liberty Corporate Finance has the experience to ensure you ask the right questions, provide you with clear analysis of your position and help you assess future indicative returns. This will give you the reassurance you need to move forward with confidence.