5 January 2022

Selling your business to private equity; explaining NewCo and vendor loan

Category: Mergers and acquisitions

You often hear the term private equity. Private equity is another name for an investment company that invests in companies with money from high net worth investors or pension funds. Many private equity investors are active in the Netherlands, including Mentha Capital, Karmijn Kapitaal, Capital A, Gilde, and one of the best known, Waterland Private Equity.

NewCo, buying shares through a newly formed company

A well-known structure used by private equity is the purchase of all the shares in your company using a newly formed company, or “NewCo”, where the purchase price is financed as follows. Private equity generally takes a majority stake. The selling shareholder is asked to also become a shareholder in the NewCo and to therefore remain as a shareholder. The idea behind this is twofold. The selling entrepreneur continues running the company to be sold and contributing his knowledge and skills. In addition, this reduces the chance of direct competition by the selling entrepreneur, who still has an opportunity to benefit from the potential growth from the private equity.

Paying in shares and vendor loan

Part of the purchase price will be paid in shares to the selling shareholder. This means that the private equity does not have to put the full amount on the table. The selling shareholder will also finance part of the purchase price with a vendor loan. This is a loan with a subordinated and therefore risky nature that also always involves subordination to the bank financing, but before the dividend payments. In these times, a vendor loan can be quite a beneficial construction. A negative interest rate at the bank does not generate anything, and vendor loans generate between 5% and 8% interest per year. The interest rate needs to be high, because the NewCo should have an interest in repaying the vendor loan as soon as possible.

As a selling entrepreneur, you agree that no dividend may be paid as long as the vendor loan has not been repaid. Part of the purchase price will be contributed by private equity itself, and part will be raised through external bank financing.

NewCo and vendor loan; an example

Private equity B purchases company A for EUR 10 million. Private equity B sets up a NewCo. NewCo pays EUR 10 million for the company. Private equity B holds a 51% participation, and the selling entrepreneur 49%. This means that the seller will not receive EUR 4.9 million in cash. Of the EUR 5.1 million, the entrepreneur must provide approximately EUR 2 million in the form of a vendor loan, which is also set off against the purchase price and therefore remains payable and does not have to be put on the table. This means that, ultimately, private equity B only has to put EUR 3.1 million of the EUR 10 million purchase price on the table.

Of this amount, EUR 1 million will be “own funds” (money from investors), and EUR 2 million will be borrowed from a bank. The loan from the bank takes precedence over the vendor loan. Ultimately, a company is acquired for a purchase price of EUR 10 million with an equity contribution of EUR 1 million.

Investment horizon around 5 years

Most private equity parties adhere to an investment horizon of around five years. This means that they will sell the company on within five years after the purchase (the exit). Be aware of this and make agreements regarding your own exit when the investor sells, to prevent yourself from getting stuck and potentially being “included in the sale”.

As a selling entrepreneur, you need to be well prepared for this type of construction. You must negotiate your maximum collateral on your vendor loan, reduce your risks as much as possible in the purchase contract, and ensure that, as a minority shareholder, you are protected by a good shareholder agreement (which will be used at NewCo level) against, for example, dismissal, unilateral changes to business plans, the accumulation of additional debt, etc.

Blenheim helps you with the sale of your business

The M&A lawyers at Blenheim can help you with this. We always advise the selling entrepreneur and have made the choice not to be on private equity’s side. Nevertheless, our wealth of knowledge about private equity helps us to maintain a strong position in negotiations. Arjen Paardekooper, for instance, is a member of the advisory board of the private equity fund MKB Fonds B.V., which means he has insider knowledge about private equity.

Do you have any questions? Or have potential investors shown an interest in your company? Blenheim’s acquisition team is here to help!