Whether you're a private equity executive or trade buyer, on the buy-side or sell-side, in the context of an M&A transaction it is critical to understand the expectations and concerns of a target company's management team. In a seller's market the willingness of the management team to embrace a new owner is all the more important, and buyers can also help smooth the transition and build a healthy long-term relationship by keeping the management team at the forefront of their plans.
This month we compare private equity buyouts and trade buyouts, highlighting five key differences as a management team may perceive them, and how they might be managed.
The success or failure of most private equity buyouts will heavily rely on the relationship between the private equity executives and the management team. The initial investment is usually as much in the individuals as it is in the business.
The relationship should be a symbiotic one. Financial reporting is a good example of where this relationship cuts both ways. Whilst a fund may have a rigid set of metrics it needs to measure against, the management team may already capture different and more meaningful data that may be key in managing the direction of the business. Equally, management should be open to listening to their new partner as they will bring a fresh perspective and may see things that are not apparent to a senior manager that is already ingrained in the business.
While a management team that follows a business into its next phase is attractive to a buyer, more value in this context is placed on the underlying products/services and infrastructure.
Integration will be a high priority for the buyer and the management team may find they have new bosses for the first time in a while. Everyone involved in the acquired business will have to adapt to a new way of doing things and it is the management team's responsibility to deliver this as harmoniously as possible.
Managers should also be prepared to up their game. Whilst a business may have found a sweet spot under manager ownership, as part of a larger group, individual business lines will be expected to increase performance to support under-performing parts of the business.
Performance expectations should always be clearly set out in both discussions and the transaction documents. With the increasing popularity of earn-out payments, this is often the case but is not a given. Making sure that the private equity house's and the team's five year plans align before the transaction is completed will often be an indication of whether the relationship will bear fruit.
Providing a mechanism for rewarding over performance can also help clearly define expectations and demonstrate a willingness for everyone to share in the short-term upside and not just at exit.
Being clear about any debt package, and providing satisfactory details to the management team, should also be a priority. Ultimately, the management team needs to be comfortable that the business can service the debt.
Trade buyers will often place value in the management team's own trading projections. In the current economic climate of uncertainty, it is important that expectations are set at a realistic level. Overpromising at the outset can lead to false expectations on both sides and provide a cause for the relationship to sour later on.
Given the relative size of the private equity fund's investment, it is reasonable that a private equity buyer will expect the last say on all matters. Having said this, the buyer will still rely on the management team's expertise and experience.
The private equity house therefore will usually have majority rights with respect to board appointments and decisions of the directors. Management may feel like their board positions are hollow, given the private equity house's typical veto rights. An effective way of bringing both sides together can be to appoint an independent non-executive as chair. Ideally the individual should be agreeable to both management and the private equity house, and have relevant industry experience, as well as solid credentials in private equity.
As the business will become a subsidiary within a larger group, key strategic and operational decisions will now come from higher in the structure. Where the acquired business has previously been owner-operated, the buyer will need to consider how best to manage the team's transition from decision makers to decision takers.
As part of a wider team, individual managers' profiles will naturally take time to build within the new group. Notwithstanding this, managers should be made to feel that they have the flexibility to grow otherwise they may head for the door shortly after the deal has closed.
Arguably, private equity buyers will provide managers with greater scope to grow and contribute. The equity incentive offered in a private equity context clearly gives managers a platform to benefit directly from the continued efforts to grow the business. Equally, private equity executives will be spread across a number of portfolio companies and therefore any team that proves itself capable with minimal input will quickly garner favour.
In a trade context, any acquisition will most likely be in connection with a wider vision for the group. Whilst key managers will have an influence on the destiny of that particular business, their overall influence will be diminished. Each manager's incentive package will need to be carefully tailored to encourage that individual to continue to improve and innovate.
5. Final Outcome
Acquisition by a private equity fund should represent the closest alignment of interest between management and ownership. Managers are clearly incentivised to maximise growth as they will share in the upside at exit. However, private equity buyers should be aware of each manager's own exit strategy. Whilst the private equity house will demand a clean break, it should be aware that key management will need to buy-in to the chosen exit route. Equally, where a private equity house will want to maximise returns, management must also be concerned with what is right for the business. Is the business large enough to go public? Has it gone as far as it can as an independent and is it time to consider a trade sale?
Managers typically enjoy greater security under trade ownership. The long-term potential upside is clearly lower than in the private equity context. However, managers enjoy the benefits of being part of a large, well-established group: salary, pension and benefits. Moreover, managers will enjoy the benefits of diminished responsibility e.g. tax filing and HR matters. Clearly, managers will be expected to perform against targets, however, the stress of ownership has been removed. The key for any trade buyer is to encourage its management teams to be business leaders without being business owners.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.