CEE: Time to sell?

Despite short term risks, the longer-term prospects of Central and Eastern Europe mean private equity owners of businesses in the region should capitalise on strategic buyers’ appetite for exposure in the region to exit their investments, argue Graham Conlon (pictured) and Anela Musat from CMS Cameron McKenna.

With the exception of one or two countries such as Poland, deal flow in Central and Eastern Europe is somewhat muted right now. There is interest from buyers but it’s just too difficult to quantify the risks associated with Greece and Europe more generally, and buyers are merely dipping their feet into the water.

As a result, one might think that now is not a good time to be seeking an exit. To think in such a manner is short-sighted.  Strategics are continuing to express a healthy interest in the region, recognising that the longer-term advantages of being here outweigh the short-term risks. Also, funds which invested in the boom years are coming under increasing pressure to exit (and return much-needed funds to their LPs). It is perhaps not surprising therefore that an increasing number of funds are actively starting to explore exit opportunities.

But what are the exit options? Trade sales are likely to remain of interest, although secondary buyouts may also be attractive – especially with respect to those portfolio companies which are perceived to have plenty of room left for value creation. Indeed, there remains a significant amount of ‘dry-powder’ out there which needs to be spent within the near future if GPs are to retain the full extent of their management fees.

Both options provide the exiting private equity fund with a relatively clean-break from the company and an ability to return cash to their LPs as quickly as possible. This is especially the case where the deal is structured as a ‘locked-box’ deal whereby economic risk is passed to the buyer from the date of the last audited accounts, notwithstanding the fact that legal title to the shares may transfer at a later date.

However, in both cases the exiting private equity investor will likely need to give some warranties. True, the standard opening negotiation position is “we are only financial investors – please ask the managers to give you the warranties that you require”, but in reality (and in comparison to the approach taken on purely Western private equity deals) it is rare in CEE for private equity funds to get away with providing absolutely no commercial warranties.

Other full or partial exit opportunities include IPOs. However these will probably form the minority of private equity exits, and will be limited to those companies which have a truly compelling story to warrant incurring the time, effort and cost (and risk in the event that the IPO does not go ahead) that goes hand in hand with preparing a company for an IPO.

Irrespective of the exit route, there is plenty that can be done now to help put portfolio companies into their best possible shape. Commercially this means continuing to drive revenue, maximise EBITDA margins and planning for the future so that an incoming buyer can see that there is sufficient cash-flow growth potential to warrant giving a high EBITDA multiple.

However investors too often focus on the bigger-picture but neglect the smaller, but sometimes equally important, details. At the start of nearly every transaction we are told “all the necessary documents are in the data room and available for your review.” But in reality this is very rarely the case – there is nearly always a chunk of missing documents, and this results in delays and costs for both the buyer and the seller / the company. Things don’t always work the same way in CEE as they do in the West. Experienced managers and advisers in the region can distinguish common-place and largely theoretical risks from real and probable commercial risks.

Whatever the planned exit route, a sale is an enormous burden on management teams. So ensure that they are properly motivated and “on-board” from the outset; for example, through the use of an appropriate management incentive scheme or retention terms.

Graham Conlon is a partner and the deputy head of international private equity at CMS Cameron McKenna, while
Anela Musat is a senior associate in the same team.