The latest analysis by PitchBook would indicate buyout activity is trending down as deal volume and values continue to slide from recent quarters. In the latest report, the triggers for the current market is discussed covering EBITA multiples, debt levels and valuations, as well as where opportunities exist based on the transactional activities of private equity funds.

Read the PitchBook report.

 

McDermott Will & Emery recently published its latest issue of International News, which covers a range of legal developments of interest to those operating internationally. This issue focuses on Private Equity.

Read the full issue.

Focus on Private Equity

The Impact of Regulatory Changes on Private Equity Firms

Taking Advantage of the Consequences of Delisting or Downlisting in Germany

Equity Bridge Facilities and the French Private Equity Market

Will Private Equity Bet on the Price of Oil?

McDermott Will & Emery has released the latest Focus on Private Equity, which provides insight on issues surrounding private equity transactions and the investment life cycle across industries. Articles in this issue include:

What Private Equity Funds Should Know about ERISA
Managers of private equity funds who are responsible for investing the assets of a fund that holds plan assets are likely to be considered a fiduciary under the Employee Retirement Income Security Act of 1974, as amended (ERISA). ERISA imposes numerous duties on fiduciaries, and those who fail to meet ERISA’s standards may be personally liable to restore plan losses, disgorge profits made through the use of plan assets, and pay additional statutory penalties imposed by the Department of Labor. The fiduciary may also face criminal penalties if found guilty of wilful failure. It is therefore vitally important that fiduciaries are fully aware of all their duties under ERISA.
Read the full article.

Fiduciary Risks Involved in Transferring Assets from a Seller’s 401(k) Plan to the Buyer’s Plan
In transactions where the buyer agrees to cause its 401(k) plan to accept a transfer of assets from the seller’s 401(k) plan, and the seller’s plan contains employer stock as an investment, the buyer needs to be aware of fiduciary concerns that may arise under the Employee Retirement Income Security Act of 1974 (ERISA), as amended. A recent decision means buyer 401(k) plan sponsors and plan fiduciaries must now engage in a process that separates fiduciary from non-fiduciary acts and carefully follows established procedures for implementing any required divestitures of former employer stock.
Read the full article.

View the full issue (PDF)

 

McDermott Will & Emery has released the October 2014 issue of Focus on Private Equity, which provides insight on issues surrounding private equity transactions and the investment life cycle across industries. Articles in this issue include:

The Use of Alternative Credit in Europe
As a result of the reduced availability of conventional credit from lending institutions in the wake of the financial crisis of 2008, Europe has been eager to develop an alternative credit market to unlock the demand for money from small and medium sized enterprises (SMEs).
Read the full article.

Buying and Selling a Craft Brewery in the United States
The craft beer business has never been hotter, with market share now approaching 8 per cent by volume in the United States and margins that have attracted the attention of private equity and venture capital investors, and even large brewers.
Read the full article.

 

McDermott Will & Emery has released the October 2014 issue of Focus on Private Equity, which provides insight on issues surrounding private equity transactions and the investment life cycle across industries. Articles in this issue include:

Proposed EU Merger Review of Non-Controlling Minority Shareholding Acquisitions: Challenges and Opportunities for Private Equity
A recently proposed plan to reform EU Merger Regulation could expand the scope of transactions subject to prior notification. For the first time, minority shareholding acquisitions that do not lead to a change in control could be subject to prior notification to the European Commission. The proposed expansion of the Merger Regulation’s jurisdiction could significantly impact businesses.
Read the full article.

IPO Market Offers Attractive Exit Alternative for Sponsor-backed Companies
The strong IPO market offers private equity sponsors an attractive alternative to the sale of a portfolio company. However, the IPO process is complex, and must be structured properly at the outset. This article discusses some of the most significant structural considerations sponsors must consider in order to be in the position to obtain the maximum benefit from an IPO.
Read the full article.

As those in the search fund community are aware, finding the right investors for a fund is critical to its success.  Equity sources bring more than their capital to the table; the best investors serve as experienced advisers and trusted mentors to search funders as they navigate the acquisition phase and beyond.  As the search fund model has proliferated both within and beyond the United States, today’s search funders may have more potential stops on their “roadshows” than their predecessors.

In seeking their ideal mix of initial investors, several of our recent search fund clients have ventured north of the border to raise a portion of their equity.  For search funds, which are typically structured as U.S. limited liability companies (LLC) with heavily standardized investment documents, taking on Canadian investors in a U.S. search fund has raised some interesting legal and practical issues.  Below are a few gating items for the search funder to consider in deciding whether to open the fund up to investors in Canada and elsewhere:

  • What percentage of your investor base will be from Canada?  The greater your percentage, the more likely it is that the search funder will want to structure the fund to cater to its Canadian investors.
  • What type of tax treatment do your Canadian investors expect?  Search funds generally utilize an LLC as the capitalized entity, which is treated as a partnership for U.S. tax purposes.  However, for Canadian tax purposes, U.S. LLCs are treated as corporations, which are subject to an entity-level tax.  This is a discrepancy that can significantly affect a Canadian investor’s economics.  The search funder may want to explore with his or her attorney whether an alternative structure, such as a limited partnership, is a viable option.
  • Do your investors have a tax presence in the United States, or will this be their only U.S. investment?  Because partnerships are essentially pass-through entities to their partners for tax purposes, investors in a partnership are inherently U.S. taxpayers.  For this reason, many non-U.S. investors prefer to invest in U.S. corporations, whereby the profits and losses of the entity are not passed through to its members.  If this is a particular sensitivity to the search fund’s Canadian investors, then the search funder may consider implementing a structure which will not result in the investor being a U.S. taxpayer.

In evaluating these alternatives, search funders should always be cognizant of how their U.S. investors may be impacted.  The above suggestions are not intended to be one-size-fits-all solutions.  As a practical matter, implementing a non-standard fund structure may affect the fund’s marketability to traditional sources of search fund financing.

Part of a search funder’s ongoing challenge is determining how best to serve its investors.  Experienced counsel can be a valuable resource in tailoring a fund to best accommodate both the search fund and its investors.  If some of those investors are Canadian, then the search funder should be aware of the issues that might affect such financiers’ investment decisions.

McDermott Will & Emery has released the July 2014 issue of Focus on Private Equity, which provides insight on issues surrounding private equity transactions and the investment life cycle across industries.  Articles in this issue include:

Latin American Private Equity on the Rise
Favorable macroeconomic trends and positive regulatory developments continue to make Latin America an attractive destination for private equity investors looking for acceptable returns in relatively stable emerging markets. Not surprisingly, some challenges remain for foreign private equity investors entering the region, but most of these risks should be manageable for investment teams and advisors with sufficient experience in those jurisdictions.
Read the full article.

Tax Considerations When Acquiring Non-U.S. Portfolio Companies—Mitigating Subpart F Inclusions
Subpart F income can diminish returns for investors acquiring non-U.S. portfolio companies by increasing tax cost. The article discusses pitfalls to be avoided and strategies for mitigating this cost.
Read the full article.

Private Equity Funds at Higher Risk of Antitrust Fines
Recent developments in competition law enforcement in Europe mean that private equity funds are increasingly exposed to potential liabilities for alleged infringements of their portfolio companies. In this article, we look at how private equity funds investing in Europe can take practical steps to mitigate this risk.
Read the full article.

I recently appeared on an episode of the Private Equity FunCast: “The Art (and Science?) of the LOI” to talk deal terms with private equity masters Devin Mathews and Jim Milbery.  This well-spent hour got me thinking about how confusing some of the deal terms in a Letter of Intent (LOI) must be for first time sellers.  As a result, we are launching a series of blog posts that will deconstruct the LOI into easily understandable parts. In this series, we will be covering the following topics:

  1. The purchase price and how it is calculated;
  2. The structure of the transaction;
  3. Key tax issues;
  4. Key deal terms, including working capital, representations and warranties, and indemnification/escrow arrangements; and
  5. The legal “mumbo-jumbo.”

We covered much of this during the FunCast, but will take a deeper dive here with a more intense focus.

The Purchase Price and how it is Calculated

For most business sellers the purchase price is the purpose of the deal – cashing in on years of sweat and hard work.  At the beginning of every LOI, the buyer sets the price (sometimes called the “enterprise value”), which is a top line number meant to entice the seller.  Keep reading.  Much of the rest of the LOI contains terms that over time may reduce the price.  So, let’s start with how the price is actually calculated, which in a typical buyout is composed of a few standard parts:

  1. Enterprise valuation (every buyer has a different philosophy on how the enterprise is valued but it is often based on a multiple of EBITDA);
  2. Reduction of enterprise valuation for debt and other identified liabilities;
  3. Increase of enterprise valuation for cash of the business (taken together, parts two and three are sometimes referred to as doing the deal on a “debt-free, cash-free basis”);
  4. Reduction of enterprise valuation for the seller’s costs of selling the business (e.g., transaction bonuses to employees, certain taxes payable by the company and the fees of lawyers, accountants and investment bankers hired by the sellers to help sell the company);
  5. Increase or decrease of enterprise valuation based on the variation in working capital at closing from a working capital target, which is generally set to approximate a normalized (i.e., average) level of working capital for the company (we will spend some time in a later blog post discussing the working capital adjustment in much more detail).

A numerical example of the purchase price calculation described above would be helpful.  The example below is based on a business with $10 million of EBITDA being valued at a 10x multiple:

Enterprise Valuation:  $100 million; less

Debt:  $20 million (assuming here that the business has a $20 million credit facility with a third party lender); plus

Cash:  $1 million; less

Transaction Expenses:  $2 million; less

Working Capital Adjustment:  Reduction of $3 million (assuming here that at closing the business fails to achieve the required working capital target)

Net Proceeds at Closing:  $76 million

But wait, don’t celebrate yet, there’s more: In most transactions there is a holdback or a third party escrow of a portion of the price to satisfy post-closing claims by the buyer against the seller, usually for 12 to 24 months.  In this example, let’s call it 10 percent of the enterprise valuation, which may or may not ultimately get paid to the seller.  In our example, this reduces the proceeds payable to the seller at closing by an additional $10 million.

Net Proceeds at Closing:  $66 million

And more: In some transactions, there is a requirement that the seller either rollover a portion of the proceeds into new equity of the buyer (rollover equity) or provide some seller financing for the buyer to close the transaction (i.e., a “seller note”).  The rollover equity usually only gets paid when the buyer ultimately sells the business.  The seller note should, at the latest, get paid when the buyer sells the business, but will often have a set term to it (e.g., two to five years).  If there is rollover equity or a seller note this could account for another 20-50 percent of the proceeds.  In our example, let’s assume a 20 percent rollover or $20 million.

Net Proceeds at Closing:  $46,000,000 (which you will note, is not $100,000,000).

In our example, however, the seller would still own 20 percent of the company on a go-forward basis due to the rollover of 20 percent, which, depending on the seller’s objectives and views of the company’s future prospects, can be a positive thing.  Moreover, the value attributable to the rollover is usually not taxable at such time – but that is a whole other subject…

The moral of the story is that when selling a business, don’t just focus on the topline number.  Read the fine print!

Stay tuned for future installments as we continue to deconstruct the LOI.