When you join the PE world, there is a whole dictionary of new words and terms to cope with. Glenn Elliott, gives his personal explanation of over 50 of these magical words, abbreviations and acronyms that get used every day. Written, as ever, in his own, straight-talking, inimitable style. Suggestions or complaints directly to him, please.
Index Adjusted EBITDAAdjusted EBITDA
When you start talking to potential PE firms, you will share your historical and projected numbers. A key thing the PE firm will do in their diligence is to try and work out what your “real” EBITDA is. That’s the number that they want in their models to work out how they should be valuing your business.
They will look to remove unusual or non-recurring items, whether positive or negative. So if you’re not paying yourself very much, they will adjust your salary to a normal market level which will produce a lower Adjusted EBITDA. If you’ve had some one-off costs or one-off cost-savings, they will adjust for them.
Your corporate finance advisor will also do the same in advance – they might adjust whatever you think your EBITDA is to what they believe is a market-defensible number if they think you haven’t handled the accounts in the way that they would. This is very normal.
A good example might be if you think your EBITDA for last year was £3 million, but your advisor notices that you paid out £250,000 as a one-off payment to a member of staff who left unusually. They can reasonably claim that was a one-off, non-recurring, exceptional item so your adjusted EBITDA for last year would become £3.25 million. Adjustments can go up and down. Your corporate finance advisor will look for ones that go up. Your bidders will be attempting to find the true figure – which is obviously a matter of some interpretation.
AdvisorsAdvisors
When you run a Process and, hopefully, complete a PE deal, there are a raft of men in suits (with the very occasional woman) who “help”. As a group, they are called Advisors. This group includes your corporate finance advisor, your lawyers and the various due-diligence providers.
Advisors produce two outputs :
- A huge raft of documents of varying quality attempting to explain your business, it’s market, the opportunities and obstacles.
- A huge raft of bills of varying sizes (see “Deal Fees“).
In my experience, there is little correlation between the size of the bill and the quality of the document. The bigger your company is, the bigger brand people tend to want on the report, then the bigger the bill tends to be.
Annual Strategy PresentationAnnual Strategy Presentation
Some PE firms like you to come and do an Annual Strategy Presentation where you give the Investment Committee (IC) an update on what you’re doing and outline what the year ahead looks like.
In my experience, these are done very patchily and, in nine PE years, I’ve only actually done two. In my research for the first one, I couldn’t find any commonality of approach from anyone who had done one before.
They seem to have three key purposes :
- Lets the Investment Committee (IC) have a look at you and see if their Investment Director is holding anything back from them (for example, that you’ve lost your mind).
- Lets the wider IC interact through a couple of well-meaning suggestions or “challenges”, (this generally reminds you that the IC only knows a tiny bit about your business).
- Let’s them tell their LP’s that it’s one of the many ways that they add value to their investments.
These presentations are definitely not something to worry about. If they are well run, they can even be useful. But don’t assume they will be great as the format is often poor. My advice is to try and take control of the agenda and rather than present how great you are, present the biggest problems you are struggling with that you would like their input on.
But if you’re running a process and one of your PE bidders says they don’t do them, you might give them a bonus point in your assessment grid.
Bank DebtBank Debt
See Leverage.
Buy SideBuy-side
A generic name for the team of people on the buying-side of your transaction. You are the sell-side, the PE firm is the buy-side. Used in the context of “sell-side advisor” meaning your corporate finance advisor and “buy-side advisor” for theirs.
CapexCapital Expenditure (Capex)
This is money that you spend on physical stuff like IT hardware or office fixtures and fittings that you depreciate over several years. People often get in a tussle about whether software development can or should be treated like this (it shouldn’t really as it is an ongoing cost – most PE firms will just add it back into costs if you present it as Capex – see Adjusted EBITDA).
Knowing what is and isn’t reasonably classified as Capex is important because Capex is outside of EBITDA, your key measure of profit as a PE business.
Capital StructureCapital Structure
When you’ve done your deal, you will end up with a Capital Structure. This is an ordered list of who gets paid first when cash is available, normally at your next exit.
The order of the list, called ranking, reflects the risk level the person is taking in your business. The risk level is connected to their return. So the people at the top of the list (highest ranking) get paid first and therefore have the lowest risk. That means they get the lowest return.
Bank debt, also called senior debt as it is senior (normally) to all others, ranks at the top. It, therefore, is the cheapest and has the lowest interest rate – maybe 4 or 5% per year. Investor loan notes normally rank second, and they will have a higher interest rate – maybe around 8% and then management rollover loan notes come next, normally with a similar interest rate to the investor notes. See Prior Ranking.
Below all of the loans comes shareholder equity. This means the loans and all of their interest gets paid off first before the shareholder’s equity gets value. This is important – it’s the thing that makes management rollover really valuable.
Confidential Investment MemorandumConfidential Investment Memorandum (CIM) or Presentation (CIP)
Corporate Finance AdvisorCorporate Finance Advisor (CFA)
A corporate finance advisor is the key advisor you employ to help you sell your business. They make a shortlist of buyers (both trade and PE), produce an information memorandum, run a process, and try to maximise value for you. Think of them like an estate agent for businesses.
Choose your CFA really carefully and take up references. They are the person representing your business to the whole market, so it’s critical that you get someone who knows what they are doing and you get along with them.
You’ll pay them an amount of money that would make a casino owner blush. That said, personally, I would not choose based on price. The right corporate finance advisor is worth it and can make a real difference to both your deal value and whether it is a success and actually happens.
Your CFA is technically only one of your advisors but, because they are so pivotal, they are often called “the advisor” or “sell-side advisor”.
As your process advances, the PE firms who think they are in with a strong chance or who just really want to win the deal will hire their own advisors to help them with their workload. They are hiring from the same pool of options as you are which means that if you get four CFA’s to pitch for your advisory business (called a mandate) then the three who don’t win it will immediately start touting themselves (and the information they have, by now, gleaned from you) to the PE firms hoping to partner up with a winning bidder. Winning bidders = deal fees. It’s a merry go round of advisory money!
Deal FeesDeal Fees
When you do a deal, a raft of advisors will have “helped”. Some of these will have worked for you; some will have worked for the PE firm. All of these hungry mouths need feeding, and they are fed with “deal fees”.
You will be undoubtedly have been running a tight business without spending hundreds of thousands of pounds on consultants; therefore, these fees will be eye-watering. However, they are unavoidable, so take a deep breath and try not to lose your cool. Fortunately (sort of), they get added to the purchase price of your business, so you don’t need to pay for them out of your own cash flow.
So, if the PE firm is paying £50m for a 50% share in your business and the deal fees are £2m, then the total cost of the business to them is actually £52m. This is the total deal cost. This eventually gets paid back, either from the cash you generate during the investment period or by being deducted from the sale price, when you sell at the end of the investment window.
The corporate finance advisor or sell-side advisor gets the biggest cheque – normally a percentage of the price paid. Next biggest cheques go to financial diligence providers, commercial diligence providers, then the buy-side advisor and so on, down to the smallest players like insurance diligence.
Due DiligenceDue Diligence
Also see Vendor Due Diligence and Red Flags.
Due diligence is the process by which a PE firm tries to assess a potential investment’s viability and the accuracy and completeness of the information you have provided.
In truth, much of the heavy diligence is done by the PE firm themselves as their work in deciding whether or not they should invest in you. Then, when you’ve accepted an offer in principle, you’ll go into an exclusivity period.
The use of external, specialist advisors to look at your business occasionally finds something that hadn’t been seen before and also covers the PE firm (somewhat) with their investors (the LP’s) if it all goes wrong later. It will take up every hour of your time available during the process, including some of the time you would normally be asleep.
There are several due diligence projects:
Financial Diligence
A report written by accountants on the financial aspects of your business. They will analyse your past accounts, your projections and assumptions and may point out things like customer concentration or any risks that they see. They check you’ve paid your taxes and produce a financial model of the business that will show sensitivities and a range of outcomes.
Commercial Diligence
This is a report written by management consultants on the commercial aspects of your business. They will analyse and explain your market, your position in it, the size of it, its growth, your customers and your product.
They will normally interview some of your customers and try and form a view of why customers buy from you, how sensitive they are to pricing changes, whether they like you a lot or just a little, and whether any big customers are thinking of leaving. They’ll look at market size and what your position is in that market.
They will also look at key suppliers and see if there are any risks or concentrations there. They’ll analyse the risk of suppliers disinter-mediating you and going straight to the customer, and the same in reverse for customers. They will do some competitive analysis and will try and work out whether your pricing has gone up or down in the past and what the pressures on pricing will be in the future.
Of all the diligence projects, CDD is actually the most interesting and can be genuinely useful for a management team. Often it is compromised by being done in a rush so try not to compress it too much (I’m assuming here you’re doing vendor due diligence and therefore you are in control)
Most entrepreneurs and management teams find the customer interviews part of CDD the most interesting and useful – it’s a relatively simple exercise that few of us get round to doing in the normal course of business and it can sometimes reveal surprises. It’s not uncommon to find that you thought customers chose you for one thing but, actually, they value another.
And others
Other diligence projects that also run in parallel include IT Due Diligence, Management Due Diligence, Sales Due Diligence and Insurance Due Diligence. They are normally thought of as the second level of diligence projects – less important. They cost less, are always done in a rush, and the corresponding report tends to be poorer and significantly less useful.
Quite often, all of these diligence projects run concurrently, and the PE firm is also still doing their own work as well. Everyone is working quickly trying to complete the deal by a deadline so you and your team will be under a barrage of questions every day. That’s why PE processes are exhausting and hugely distracting to the management team. See post-deal slump.
EBITDAEBITDA
Pronounced “eee-bit-dar”. Get used to this, you’ll be saying it and hearing it every second sentence.
EBITDA stands for Earnings Before Interest, Tax, Depreciation and Amortisation of Assets.
It’s the key profit metric that PE firms are interested in, and it’s the profit line that is used as the measure when valuing your business.
So if your business made £9m net profit, before taking a £2m depreciation charge on equipment (Capex) and paying tax of £1.5m, everyone is interested in the £9m not the £5.5m of profit that you’ll actually report at Companies House.
This focus on profit before depreciation causes the interesting effect that capital expenditure is ignored when looking at your profit line as long as it is not too material. So, the money that you spend on computer equipment, office fit-out and other cap-ex items doesn’t hit your profit line, it’s essentially free. Everyone head down to the Apple Store!
The reason that PE firms don’t pay attention to depreciation is because it is just an accounting number spreading the capex over time. They care about the capex when it is spent on Day 1 as that is when it impacts cash flow then. PE firms generally avoid businesses that are Capex-heavy. That makes depreciation charges low for most PE-owned businesses.
For PE, cash is really king, and they will be modelling cash above everything else. EBITDA is a close proxy to cash in the type of businesses that they typically buy.
Exclusivity PeriodExclusivity Period
The exclusivity period in a sale process is when the PE firm starts paying hard cash for external consultants to confirm what they have found. See Due Diligence.
For a £50m – £100m investment, the PE firm might spend £300k – £400k on diligence fees. If the deal does not happen, they lose this money (called abort fees), so they only do this when they’re serious about completing a deal. These buy-side diligence fees are only a small part of total deal fees on a successful transaction.
You start an exclusivity period by signing a short agreement or letter saying that you will now deal with that PE firm exclusively and not talk to others. You’ll put your other bidders on hold, so they know they’ve lost (or are likely to lose) the deal.
If you fail to agree final terms during your exclusivity window, or your PE firm pulls out, then you can go to your other bidders. In this situation, though, other bidders will want to know why your deal fell apart. This is a situation where it will really help if you did Vendor Due-Diligence as you can take your DD with you to the next bidder.
ExitExit
An “exit” is the name given to the event at the end of a process that leads to some, or more rarely all, investors “exiting” their investment and realising the value of their equity as cash. PE deals are most commonly management buyout’s where the PE firm is backing all or a subset of management to grow the business.
Management who are continuing, sell their shares in the exit but then roll-over some (often half) of the proceeds to re-invest back in the company. See management rollover.
Fireside ChatFireside Chat (FSC)
A key part of your deal process normally around the time that your teaser comes out. Your advisor will arrange for you or your management team to have a series of shortish, maybe an hour, informal (not really everyone is still on best behaviour) chats with some selected possible bidders (probably everyone on the long list).
These are billed a a fireside chat, I think, because the name is meant to invoke the idea of a cosy, intimate fireside conversation between a very select few bidders and management. The fact that you might do 15 or 20 of these does mean that they tend to blur into one and, of course, all of the PE firms end up looking rather the same. In theory they mark the soft-launch of your process. In practice, everyone will already know your process started as soon as you appointed an advisor because all of the other advisors who you met but didn’t choose will have gossiped and leaked it to the market.
Your advisor will help you make a Fireside Chat Deck or Presentation that you will walk through during the meeting. It will be longer and in more detail than the Teaser, but not as in-depth as the Management Presentation.
If you are lucky, a few of the PE firms will prove to be obnoxious enough that you will cross them off your long list therefore making later stages of the process easier.
In these pandemic days, a more appropriate name would be “Zoom Coffee Call”.
Financial SponsorFinancial Sponsor
Yet another name for your PE investor. They are interested in your business purely for financial reasons. Contrast with a Trade acquirer which might be interested in you for strategic reasons.
Follow-On FundingFollow-On Funding
Follow-on funding is generally provided when you’re doing an acquisition that your board and your investor’s investment committee has approved. Funding could come from a bank as a loan, or it could come as additional capital from your investor. PE firms generally reserve a bit of spare money in every fund for follow-on capital that might be needed. Sometimes you don’t need it because you might have enough cash in your business for the acquisition.
In general, though, follow-on funding is not available just because you’ve missed your sales target, let costs overrun and have run out of cash. So don’t think your PE firm will be standing by the side like Santa with deep pockets to cover a cash crisis. Those circumstances are really rare – in general, you are expected to run the business independently. It’s one of the reasons why PE generally has a minimum revenue and profit threshold as everyone wants to know your business could take some hits and still be viable.
General PartnerGeneral Partner (GP)
Another name for your PE house. The principles in charge of your PE firm might call themselves the General Partners.
Hockey StickHockey Stick
Used as in “hockey stick projection” or “hockey stick forecast”.
A surprising number of Investment Memorandums (IM’s) include a revenue, and or profit, forecast which is illustrated by a chart that shows a flat line followed magically by a sharp upturn in the near future, therefore, looking just like a hockey stick.
The company being sold is normally at the end of the flat line, just about to shoot up. Your CFA might encourage you to put something like this in but resist if they do, PE firms generally hate them, and it’s an instant way to lose credibility. It’s always better to under-promise and over-deliver. Otherwise, confidence and credibility can evaporate quickly.
Investment CommitteeInvestment Committee (IC)
The group of senior partners, and sometimes non-executives that ultimately decide on which asset to buy.
Your investment director will represent you to the IC, write investment papers explaining the investment opportunity, and answer their challenges and questions.
Investment Committees almost always seem to meet on a Monday, so you’ll find your investment director there presenting nervously toward the end of your process.
Investment DirectorInvestment Director (Deal Lead)
This is the person at the PE firm who is responsible for buying your business. They end up sitting on your board, normally for the duration of the investment. Their fortunes are closely tied to yours – they bought you, and their reputation is on the line. They will deeply want you to succeed.
So the two people who should wake up each morning worrying about the business performance and fretting about how to execute on the opportunity are the CEO and your new partner, the Investment Director.
Investment Directors tend to stay surprisingly long periods with a particular PE firm, partly because their earnings are tied to the investment cycle. So they’re on a six-year delay to get paid their bonus for your successful investment period.
You should really like the Investment Director that is bidding for you as you’re going to be their partner for the next four or five years.
Investment MemorandumInvestment Memorandum (IM)
A document written by you and your corporate finance advisor that explains your business and the investment opportunity to potential investors.
An IM will normally include a description of the business and your products, your market, customers, competitors, risk and opportunities. It’s essentially a brochure for your business, so it leans to an optimistic, rosy future. Trust and credibility is key though so don’t allow yourself to present something that is not deliverable.
Occasionally an IM is called a CIM which just means Confidential Investment Memorandum or CIP which is Confidential Investment Presentation. It’s a pointless additional abbreviation really as all IM’s in PE are confidential.
Also see hockey stick projection which can be found in a surprising number of IM’s.
Investment PeriodInvestment Period
This term means the period of time that your investor holds your company as an investment. In PE, it is typically four to five years. Around that time, assuming things have gone vaguely to plan, you will start a process to find your next investor. This could be another PE firm (this is then called a secondary buyout, or even tertiary if you’re on your third) or it could be a trade sale (or even rarely a public listing).
LeverageLeverage (Bank Debt)
Leverage is a fancy word for debt or borrowing money. You need leverage in private equity as most deals are structured as a leveraged buyout. Commonly the debt comes from a bank; hence it is often called bank debt to distinguish it from the loan notes you have with your investing shareholders.
Most often, the leverage is arranged at the same time as your deal. Sometimes the PE firm pays in full, though, and the bank debt is done later, normally within 12 months. This can be helpful when your current level of EBITDA isn’t high enough to raise the level of bank debt you need, but you think it will be in 12 months time. Banks typically lend you a multiple of your EBITDA so getting your EBITDA up means you can borrow more.
It’s natural to think borrowing money from the bank is bad, and it is true no one wants to be over-leveraged. But bank debt is much cheaper than PE investment, so your overall deal will be better for you by using a sensible amount of bank debt. It will make your rollover equity earn more for next time you exit. See below, Leveraged Buyout.
Leveraged BuyoutLeveraged Buyout (LBO)
Most PE deals are structured as a leveraged buyout, meaning they rely on borrowing from the bank as a way of paying for the acquisition of the business.
The reason for this is that it is cheaper to borrow money from the bank than it is to borrow it (get it through investment) from your PE firm.
A PE firm typically wants to triple the size of its investment over a period of four to five years (any more is gratefully received). Whereas, a bank might only want 6% interest per year.
So if you got £10m of funding each from a bank as senior debt, and your PE firm (as an investment), the PE firm would want you would turn that £10m into £30m in five years, but the bank would only expect £12.6m back.
Banks are cheaper, and therefore much more risk-averse than PE firms. So a PE firm might value your business at 10x EBITDA, but the bank might only lend you 4x EBITDA. The gap in between those numbers in your deal structure is funded by permanent capital.
Limited PartnerLimited Partner (LP)
LP’s are your investor’s investors. They are the people and companies who invested in the PE fund that your business is being bought by. They are often pension funds, teachers pension plans, university endowments, charitable foundations or even large family offices. They will likely invest in several PE funds, often from several PE firms.
You may never meet the LP’s unless you’re invited to present at your PE firm’s AGM. But the LP’s will know you and your company from the PE firm’s regular reports. I’ve met several, and I was amazed at how much they knew about my business. The PE firm will report back to them regularly on how everyone in the fund’s portfolio is doing.
Loan NoteLoan Note
A Loan Note is literally what it says – a note of a loan. There are two key things on a loan note – the capital amount owed and the interest rate, sometimes called the “ticket”.
Loan Notes are typically created on a PE Deal in two situations:
- When the PE firm invests, the total amount of their investment (the “equity cheque”) plus the deal fees are entered into the company’s balance sheet as a loan note.
- When you (or other shareholders) rollover some of your proceeds as part of your investment deal, you will get a loan note for the amount you roll – See management rollover.
Management
The “management” of the company – essentially, you and your team. Used as in “let’s ask Management” or “how are Management doing?“, or “Management – keep/replace?”, which I once saw on an investors deal evaluation template!
Management DinnerManagement Dinner
Right at the very end of the process, when you’re absolutely exhausted from several months of questions, diligence, presentations, advisor calls and working through issues and documents are the Management Dinners.
This is where you and your executive team go for dinner with your final shortlist of PE firms so that they can confirm that you know which way to hold a knife and fork. PE firms love to look you in the eye over dinner; they get a great sense of safety from this (largely unfounded in my view).
PE Investment Directors generally tend to be very charming, and most have surprisingly good social skills given that they are accountants. So dinner with them in a fancy restaurant wouldn’t be the worst thing were it not for the timing. At this point in the process, you are knackered and really want an early night. If one of them comments that you look tired, try not to attack them with a spoon.
MarketMarket, as in “The Market”
“The Market” is the collective name for all of the advisors and people swimming about in the PE pond when the person talking doesn’t want to reveal who said what.
So when someone says “Feedback from the market is that so and so is going to get their offer rejected”, it translates to “An advisor told me in the pub last night something that is supposed to be highly confidential”.
One of the things you learn about PE is that it’s a small pond, and all the advisors end up working for everyone. So your lawyer is on your side working against Investor A on your deal but is simultaneously working for Investor A on another deal.
I was bemused / surprised when I first learned all this, but it does have some significant benefits. All PE firms have their little oddities of things that they ask for, things that they must have and things they just try and get when they can. Having a lawyer or other advisor who knows your opposite partner’s ways can be helpful in avoiding asking for or demanding things they will never give and focussing on where you can get a win-win.
Management RolloverManagement Rollover
No, this doesn’t mean you rolled over like a dog and gave the investor what they asked for. Management rollover is the term given to the amount of your sale proceeds that you roll over into the new (post-deal) company structure, often called NewCo. As a general rule, PE firms like Founders to roll over about 50% because this shows that you continue to be interested, invested, and believe in the business that you are selling to them. This is why Founders are typically called “a buyer and seller” simultaneously.
This is how it works:
Imagine you own 60% of your business that for simplicity we will value at £10m. Again, for similarity, assume there is no bank debt.
Your 60% of £10m would be £6 million. But you can’t have all of that; you have to roll over some of it. You agree 50% so you will get cash-out of £3m and you roll £3m into the new company structure.
In exchange for the £3 million rollover you will get two things:
- A loan note for £3 million – so the company owes you this back and will pay compound interest on that until it does, plus:
- Shares in your NewCo in exchange for your £3 m.
Two things are of interest here – firstly you get two things back for your £3m. It buys you shares in your NewCo, but you also get a promise to pay the £3 million back on top (your loan note) plus the interest. So if this makes you feel that you are getting the shares for free, well that’s kind of true – you are. It’s the same deal that your investor gets. They will also get shares in NewCo equivalent to the amount they are investing, plus a loan note back for the amount of permanent capital that they invested.
The maths of this are really important. Assume your investment period is five years and your loan note is at 8% interest paid annually and compounding every year. The interest on that loan is worth £1.4 million alone. So your £3m rollover will return £4.4million plus you will get the value of the shares that it bought on top, Management rollover is really valuable!
The second thing that is of interest is that you get more shares than you expect. So you originally owned 60% of your company, and you reinvested half of your proceeds, so you might expect to now own 30% of your NewCo. But, actually, you will own more because of the way the debt works (ask your CFA to explain the detail).
Also see Sweet Equity.
Mezzanine FinanceMezzanine Finance
A funny name for money that’s somewhere between bank debt and investor debt.
Riskier than bank debt and, therefore, more expensive. Less, probably much less, expensive than investor debt. If you can raise £10 million in bank debt, a mezzanine finance provider will likely lend a bit more, but you will pay a higher interest rate for the privilege.
Multiple ArbitrageMultiple Arbitrage
I love this term. It sounds really fancy and complex but it’s really very, very simple. It is basically the difference in price you get between buying and selling due to circumstance rather than making something better.
Generally, in growth PE we are valuing businesses based on a multiple of EBITDA. Small companies attract a lower multiple as they are seen as sub-scale, a bit more risky and small deals are just less attractive than bigger ones. So if a bigger company buys a smaller one then even before synergies or cost reductions, because the two companies are now 1, the total EBITDA of the combined companies now attracts the higher multiple of the larger one.
Here is a worked example :
Company A has £10 million revenue, makes 3 million EBITDA and is growing at 30% per year. It is valued by PE at 15x EBITDA which is £45 million.
Company B is much smaller and has £4 million revenue and £1 million EBITDA. It is also growing at 30% per year. Because it is small, and small deals are less attractive, it is valued at only 8x EBITDA which is £8 million,
If Company A acquires company B then immediately the combined group would be seen as being worth the larger multiple – 15x. That means the £1 million of profit from Company B that you just bought for £8 million, is overnight, magically worth £15 million. Not bad for a quick acquisition is it?
So that, simply, is multiple arbitrage
Permanent CapitalPermanent Capital
Capital (money) provided by the PE investor from their PE fund. This is expensive capital compared to bank debt. Normally put into a business with a matching loan note, so the capital amount itself is protected if the equity price falls to zero.
PE investors generally want a return of 2.5x – 3x on their permanent capital. Some investments “pop” and can do 4, 5, 6, 7x or more.
Normally the bulk of your purchase price is paid in permanent capital, with the rest being paid by senior debt then management rollover.
Post-Completion PlanPost-Completion Plan or 100-Day Plan
This is a list of things to work on after the deal is complete. Sometimes called the 100-Day Plan as there is a hope that it might all get done in the first three months.
As you go through your process, your investor and diligence providers will unearth things that are not ideal or need to be fixed but are not severe enough to derail the acquisition. These get dropped onto the post-completion plan.
Don’t worry too much about this, just let it happen.
Once completion is done (and you’ve had a holiday), you can re-look at the list and edit then – it’s much easier to argue that something isn’t really important at that stage. And be warned that much of it is diligence rubbish, I get embarrassed sometimes about the nonsense that can get on these.
Post-deal holidayPost-deal holiday
OK, I’ll be honest, this isn’t a real term, but I think it should be, so I’m including it and hoping it will become a thing. Once you’ve signed the deal, you need a week or two off. PE is a four to five-year cycle, so a week or two isn’t going to make any difference.
You’ll be mentally exhausted after the deal so your decision making will be compromised and you need a break. Take some time to spend with your family and friends who you probably haven’t seen for the last four or five months. Watch out for the post-deal slump in your mental health.
Post-deal slum (financial)Post-deal slump (financial)
It’s not uncommon for a company to grow slower during the first year of PE ownership than before. In fact, some companies can struggle or even go backwards in year one, and this is a situation reported by many of my CEO colleagues in PE and a number of PE funds. Everyone tries desperately for this to not happen, but it does.
The reasons for this can include:
- The management team has been hugely distracted for the nine months prior to the sale (by doing the sale), and that can impact negatively on product, business and organisational development.
- The management team is exhausted by the sale process, confused by their new ownership structure and struggling under the weight of “helpful” suggestions from the diligence providers.
- Trying to do too many new things at once in an effort to grow the business faster actually makes it go slower. A classic example of this is adding too many new salespeople who then consume management resources to recruit and train, so sales go backwards not forwards.
- In an effort to maximise the sale price, your sell-side advisor persuaded you to stretch all of the projections to the fringe of reason and, in year one, you have the hangover from that party!
Post-deal slump (mental health)
You’ve just done the most exhausting four months of your working life running a process whilst trying to keep the wheels from falling off the business. You’ve made a big chunk of money (hopefully), and you have a bank balance that you never dared dream of.
It is very common now to have a post-deal slump in your mental health where you feel somewhere between flat, depressed or overwhelmed. You might wonder why this huge bank balance doesn’t feel as good as you thought it would and your chest feels heavy with the weight of the five-year plan that you’ve just sold to your investor.
Trust me, I’ve done this twice and have counselled several founders through it. When this happens, don’t feel alone, it is normal. Call me and we can talk about it.
Prior RankingPrior Ranking
Prior ranking is a term connected with your capital structure. It is used to show that one debt item has prior ranking, i.e. ranks higher, therefore, gets paid back first when compared to another. You will commonly hear it in association with investor loan notes which often have prior ranking over management team loan notes. This is advantageous to the PE firm as it lowers their risk in the event that things go wrong with the investment. If the investment goes to plan, then it doesn’t have any effect as all loan notes would be paid out in full anyway, regardless of the order.
ProcessProcess
A process is the project that results in an exit. So you’ll hear things like “Company X has just started running a process”. It is where you, the management, appoint a corporate finance advisor to find the new investor (owner) for your business. They will work with you to produce a teaser and an investment memorandum and represent you to the market.
When the process is complete, assuming it was successful and you survived the dreaded management dinner and ended in an exit then you will have your new owners. Then you can get cracking on the 100-Day Plan and attempt to avoid the post-deal slump. About four or five years later, you will do it all again!
Red FlagsRed Flags
For all the money that you spend on due diligence, you would think they would come up with something concrete that you can rely on. This is not how it works.
Due Diligence Advisors try to get away with saying as little as possible that they can be sued for in the future. So getting them to say anything concrete is like trying to catch a slippery eel. Some even go so far as stamping “Not to be relied upon” as a watermark in the document.
An advisor will never go so far as to say that a business is a good or bad investment opportunity.
So instead of putting themselves on the line, their main output is to raise “red flags” which are things that might be something to worry about. It’s then the investor’s job to work out if the red flags are real deal-breakers or not. These can be irritating if you know they are nothing to worry about. That’s a good reason why you should consider vendor due-diligence because at least you see them then and can argue about them.
Some red flags may get dealt with in the Post-Completion Plan or 100-Day Plan.
Secondary BuyoutSecondary Buyout
When you’re already PE-backed and sell to another PE firm.
In the old days, these deals were seen as a bit “off”. The idea was that a company under PE ownership should maximise its lot in life and then do a trade sale. If you sold to another PE firm, then you had “left value on the table” for the other PE firm.
This is no longer the case with many companies going through multiple rounds of PE ownership. Some PE firms have even been known to buy back assets that they owned previously, wanting a second spin on the wheel.
Sell SideSell-Side
The opposite of buy-side.
Senior DebtSenior Debt
This is any money that is borrowed that ranks (in terms of who gets paid back first) senior to the investor. So this is normally a fancy word for money you borrow from the bank. (See Leverage and Leveraged Buyout).
You can borrow money for normal business investments, but in the context of a PE deal, the first and primary use of bank debt is to part-finance the company’s acquisition by the PE fund in the first place.
Bank debt normally ranks ahead of any other debt or loans, so it is paid back first when you sell or refinance. Bank debt is low risk, low return which is why it has to be paid back first before anyone else gets their money.
Sweet EquitySweet Equity
When you agree a deal, there are two things that are key to management :
- The price the investor is paying – often called the Enterprise Value or EV
- The sweet equity pool that the investor has built into their financial model
Sweet equity is an amount of shares that the investor has reserved in their model to give to management, i.e. you. It is called sweet because it is very cheap, in fact, it is normally allocated early enough in your deal cycle that it is free of charge. That’s because the debt that gets put on your balance sheet as part of the deal puts the value of your shares “under-water” or at zero for a while (See Capital Structure).
PE firms allocate sweet equity because they see it as a key way to incentivise the management team and align their interests with yours. The idea is simple – if the management team owns equity in the business like the PE firm does, then the management team is incentivised to grow the value of all of the equity.
Sweet equity is valuable and is a key part of the PE management buyout model. It is common for sweet equity to be allocated to the executive team, which will always include the CEO, CFO and Chairperson and most often includes people like the Sales Director, Director of Customer Services, Chief Product Officer.
You can allocate sweet equity to anyone in the business, not just directors. Some businesses also go to the next level down below exec team. A very small few allocate sweet equity to all employees under something normally called an employee share plan.
There are two schools of thought on sweet equity. One is that you should concentrate it on the small few people who really make a difference so that they can get serious, meaningful amounts. The opposite view is that you should share it widely, maybe to all staff, so that everyone feels a sense of ownership.
Personally, I am of the latter view, I have always reserved a few percentage points of sweet equity to share between all employees in the business. That’s how I created a broad sense of ownership and alignment. Not many companies do that – as ever, I’m an edge case but talk to me if you are interested in exploring it.
TeaserTeaser
This is a very short document, sometimes just a two-page PDF that your corporate finance advisor sends out to flag to the market that you’re thinking about a process. It includes some very high-level information on your business, and its key job is to see what the initial market interest is.
A teaser is really the first outwardly visible part of your process, assuming your appointment of advisors has remained a secret (highly unlikely!).
Trade SaleTrade Sale or Trade Deal
When you sell your business to another business, sometimes a competitor rather than a financial sponsor like a PE firm. Also known as “A Strategic”, eg. “They sold to a strategic”, meaning they sold to a strategic buyer.
Strategic buyers are revered because they can, and often do, pay more for a business that PE can because they are buying for a strategic reason, rather than a purely financial reason.
Vendor Due DiligenceVendor Due Diligence (VDD)
Due diligence is something the buyer performs on your business in order to prove or disprove that your business is an asset worth investing in. But if you, the vendor, are confident of completing a sale, you can commission the diligence yourself – this is called Vendor Due Diligence.
Typically, Financial Diligence and Commercial Diligence are the two projects that are done within vendor due diligence. The other, secondary diligence projects are normally done by the buy-side during their exclusivity period.
The advantage of VDD is that you own it, so it puts you in much more control of your process. If your discussions with one PE firm break down, you can take your IM and your VDD to another PE firm and continue a discussion there. The downside is that you have to pay for it and if a deal doesn’t happen, you won’t be able to bury it in the deal fees.
You will use the same advisors to do the DD as your PE firm would – they’ll take money from anyone. But a second advantage is that they’re working for you, whilst attempting to keep some semblance of professional independence, so you will see many drafts of the DD report and can tell them when they’ve got the wrong end of the stick. This is hugely preferable to buyer-DD where you might never see the report, and your potential buyer could make a decision based on flawed information or analysis.
Back in 2010, when I did my first deal, Vendor DD was still a bit special, but now in 2021, it’s very normal. I highly recommend it because it puts you, not the PE firm, in control.
Venture CapitalVenture Capital
Venture Capital or VC investors are very different to private equity investors. They invest in startup and early-stage investments, pre-revenue, pre-profit, often even pre-product.
By contrast, PE investors specialise in growing, profitable cash generative businesses.
This different approach hugely affects risk, ambition, deal structure and outcomes for entrepreneurs. See this article for more details on the differences between PE and VC.
