The benefits of a private equity transaction

At the Deminor event, last 15 December, at the Ghelamco Arena, colleague Wim Van der Meiren gave a presentation on the benefits of a private equity transaction. In this article, we would like to give you a brief summary of the main takeaways.

The private equity sector is still going full steam ahead. In Europe, some €100 billion a year has been raised in recent years, mostly from entrepreneurs, family offices and high net worth individuals, to invest in unlisted companies.


Leveraged buyout

The sector is typically organised through private equity funds professionally managed by teams of investment managers, each with their own focus and investment criteria. For instance, there are the typical ‘closed end’ funds, which have a maturity of around 10 years. But there are also quite a few family offices and investment holding companies with no defined end date (the so-called ‘evergreens’) that invest with a different philosophy, being for the long(er) term and without pressure from external shareholders.

Speaking of mature companies/SMEs that have both in their sights, the common thread throughout such deals is that they are typically structured through the principle of 'leveraged buyout'.

It basically means that the entrepreneur, who is usually 100% owner, gives up control of his company in exchange for a minority stake in a Newco (with the private equity player as majority shareholder). This Newco takes over the entire shareholding and also raises acquisition finance through the bank to do so. This structuring allows the entrepreneur to secure a significant part of the value of his company (and possibly his total assets), while also acquiring at least a blocking minority for a relatively limited reinvestment.

A numerical example makes this clear. Suppose a deal is struck with a private equity partner based on a share value of €100. A Newco acquires the shares, paying for them with €35 equity, €60 bank financing and €5 vendor loan (‘vendor loan’). The entrepreneur reinvests 40% in the capital for a stake. In the end, the entrepreneur puts 19€ on the table and sets aside 81€, which can be reinvested to create passive income. But it goes even further…


Value creation

Every year a not insignificant part of the company's cash flow is used to repay Newco's debt financing, increasing its share value year-on-year.

Eventually, typically after 6-7 years, Newco becomes debt-free with an equity value of €100 (without taking into account other factors/influences). A simulation by Deminor based on a set of standard parameters shows that this gives an IRR (internal rate of return) of over 21%, compared to 11% in an independent scenario. The difference becomes even greater if one assumes that a partnership leads to extra growth in EBITDA (both organically and via buy & build acquisitions), which can also lead to a higher multiple. This clearly points to the strength and appeal of the private equity model.


Benefits and concerns

As an entrepreneur, you can benefit in many other ways from a private equity partnership. For example, the board is professionalised and room is created for a corporate governance policy with checks and balances. Operationally, the private equity player acts as a sounding board and, via its investment team, also provides (ad hoc) support for certain optimisations (digitalisation and streamlining of processes, automation, cost control, strategic acquisitions, etc.) Finally, a buyout also proves to be a useful tool as part of broader succession planning, both financially (funds can be partly given away) and in terms of the continuity of the company.

Of course, there are also a number of concerns we would like to point out. In addition to the loss of control, the decision-making process weighs up somewhat. You should also be aware that there are several reporting requirements (e.g. a monthly dashboard) and that financial drivers predominate. Also, an exit deadline usually applies and you are bound by a number of contractual conditions such as a good leaver, bad leaver and non-compete clause.

For questions on the structuring and financing of a private equity transaction, please feel free to contact Wim Van der Meiren.

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