Friday Letter: The management factor

Competition is good for business - especially if you are part of a management team helping take your company through a sale involving multiple bidders. And few GPs need reminding that most transactions today are indeed auctions.  

In this crowded buyout market, where capital-rich general partner groups compete fiercely for an increasingly finite amount of investable assets, management teams have huge sway in determining who their businesses are being sold to. When more than one suitor comes in with a satisfactory financial offer for an asset, a vendor may not be all that bothered about which suitor the asset ultimately goes to. But maybe the management team have a view? You bet they do; and in today’s environment it can be a dealmaker or breaker.

Earlier this week, one of London’s leading transaction lawyers told PEO the tale of a recent large, high-profile LBO that perfectly illustrates what might be called the management factor. In the final stage of an auction, with just two bidders [both private equity firms] still in the running, the seller found itself in the happy situation of having two seeming equally attractive proposals on the table. So what did the management team think?

Two separate meetings were held where each bidder was presented with the managers’ preferred terms: sizeable equity participation, no warranties and a commitment to putting in place a sizeable war chest to fund acquisitions.

The bidders’ reactions couldn’t have differed more: “No problem, we like it – done” responded House A. “Erm… maybe, uh-huh [long pause] … can we talk about that later?” was the feedback from House B. Soon after a winner was declared, and it won’t come as a shock to hear that the latter firm came second.  

One scenario where management are in a particularly strong position is the increasingly ubiquitous secondary buyout. Holding a sizeable chunk of equity in the company already, management may like the idea of cashing in rather than rolling their stakes over into the Newco. From the point of view of the new private equity owner, keeping the team on board is typically the preferable option, and in order to get that done, there better be a good reason for the managers to sign up for another round therefore.

For private equity firms, having to accommodate management to get the deal done can seem costly, especially at a time when management have plenty of leverage. However, this also constitutes an opportunity: making friends with management by way of offering the most compelling alignment of interest can deliver the necessary edge over other bidders – something all financial buyers are looking for.

It also creates an advantage when it comes to seeing off trade buyers. Unless these firms are themselves private equity-backed and can liberate meaningful amounts of equity-flavoured incentive [and remember, stock options in public companies are regarded with circumspection by many], these buyers will not have as much flexibility to give management what they want compared to an equity sponsor. At a time when trade buyers are keen to move back into the M&A market, this differentiator cannot be ignored.

Buying well remains one of the things that successful private equity firms have to be good at. Keeping an eye on managers’ needs is very much part of that – and may often hold the key to buying better than the rest.