18 September 2022

Help, there’s an investor at the door! What to do when private equity comes knocking

Category: Mergers and acquisitions

Private equity is a fancy name for an investment company that usually works with money from private individuals. It is, therefore, explicitly not a bank. Private equity can approach you as an entrepreneur for a full or partial takeover of your company. But you, in turn, can also approach them if you are looking for growth capital.

In this blog, I discuss the position of private equity as an investing/acquiring party. In these times, you, as an entrepreneur, are in high demand: there are few investment opportunities for private equity, and money is readily available.

Private equity as a partner for the entrepreneur

Private equity presents itself fundamentally as a partner for the established entrepreneur. This generally means that private equity, as an investor, takes over part of the shares, with an option to take over the remainder within a certain period, usually at a predetermined (minimum) price. This period is generally three to five years.

This is obviously not on.

After connecting with private equity and exchanging information (after signing a confidentiality agreement, of course), a non-binding offer (NBO) is often made. In this offer, the investment company indicates how they want to participate, for what amount, and at what valuation – and then the negotiation game is on.

Payment of the purchase price by private equity price

Private equity will try to avoid paying the purchase price all at once. They often try this with one part cash, one part vendor loan, and one part earn-out. This is a way to keep the selling entrepreneur “on his toes”. This is where an experienced lawyer can make all the difference for the business owner. If you’re not careful, you could be funding the acquisition yourself, and the risk is on you as the seller. You should never underestimate what might happen.

Room for negotiation when selling your company

Experience shows that there is room for negotiation, especially for entrepreneurs in these times. Private equity is overflowing with money that yields negative interest rates, and there are too few companies to invest in. A wonderfully comfortable position for the entrepreneur. Take advantage of it! The decision of whether to give the investment company a minority or majority stake is clearly important. Some investment companies only want to invest if they get a majority stake. In practice, this is also negotiable.

The private equity investment method

It’s all well and good that private equity wants to take over part of the shares, but how much will they invest in addition, and how? Usually, private equity does invest, but they attach all sorts of conditions to their investment. For example, they often use a so-called “cumpref structure”. Cumprefs are cumulative preference shares, which give private equity, in addition to their shareholding rights, the privilege of a (high) interest on any invested funds. This right takes precedence over dividend payments but is after repayment of any bank loans. Cumprefs can be a cause for concern. Interest rates of 6% to 8% are not uncommon, and if no interest can be paid or the bank does not allow payment, the interest on interest accumulates quickly. If the company is sold, repayment of the cumprefs takes precedence.

Make clear agreements when selling

Depending on your position, whether you are a minority or majority shareholder, it is crucial to make good agreements with the investment company. Agreements must cover the management fees, dividend payments, and what to do in the event of a future bid. But also consider the question, “What if additional investment is needed?” The investment company always has deeper pockets and then you have to make agreements on whether this is in the form of a loan or by issuing shares. The latter would weaken your position as an entrepreneur – something you generally want to avoid. That is something you can think about beforehand and rule out.

Because there is such a wide choice of private equity, choose the best private equity with the most added value. It’s no longer just about money in this day and age. You should see whether they have any similar investments in their portfolio and whether their knowledge, expertise and network would benefit you. These ancillary skills and contacts are just as critical as the money.

Blenheim advises entrepreneurs on sales to investors

The lawyers in Blenheim’s corporate team have extensive experience in advising entrepreneurs when private equity is on their doorstep as an investor or acquirer. We do not work for private equity; we have always chosen to be on the other side.