Breakthrough Deals – The art of dealmaking

Between them they've closed thousands of deals worth billions of pounds.

Our panel of M&A heavy-hitters give their top tips on dealmaking through the credit freeze and avoiding the pitfalls

Do distressed deals – Jon Moulton – Managing Partner, Alchemy Partners

Debt finance is now only obtainable on slow and nasty terms – and not much fun, so we are really looking at unleveraged deals, smaller public-to-privates and businesses at the difficult end of life. There is plenty of it coming in.

We’ve always focused on difficult deals and turnarounds, so our strategy more or less plays itself at the moment. There are lots of turnarounds and we’ve seen increased forced selling: virtually anything can get into trouble.

We also have a distressed debt fund, which is of course very much the form of activity that you want in these markets – that’s not buying companies but investing in their debt.

For the most part, I would say that we are not receptive to doing deals in retail, which are mostly ending up in pre-pack administrations rather than private-equity backed turnarounds. We are finding it tough to do deals in construction-related activities because of the massive uncertainties. In terms of sector, usually we are pretty agnostic.

You shouldn’t miss the opportunity of doing acquisitions of distressed competitors. It is risky and difficult, but those who actually succeed in doing so will look awfully clever in two or three years’ time.

The ideal foundation for a successful turnaround is a decent-to-good business. It should be one that has survivability, growth and ultimately some value – in other words, not a Woolworths. We also look for a tight-to-terrible balance sheet, one that allows us to put in money in order to take control through the equity. The management might be anything from truly appalling to very good. If the management team is good, it should have arrived recently, otherwise we will be a bit short of a turnaround plan. At the moment, I would say that’s what we’re looking for. A great business with good management generally isn’t an easy combination to deal with.

Look at a partial sale – Peter Cullum – Executive Chairman, Towergate Partnership

It’s still a distressed market that will recover in 2010, but not to the levels that we saw in 2007. I suppose you’ve got to sit back and really question the necessity of doing a deal in 2009 because, by and large, illiquidity is a problem and it has become a buyer’s market.

Those contemplating an exit should have a serious think about a partial sale rather than a final exit. Taking money off the table now and having a formulaic valuation for two or three years’ time, gives vendors a degree of certainty, but doesn’t lock them into what they may regard as a low-value deal.

Over the last six to nine months, valuations have fallen quite dramatically within the general insurance space. One of the biggest problems is that vendors are finding it difficult to come to terms with this and are still looking for EBITDA multiples that were prevalent in 2007. It is a huge shock to vendors to suddenly find that their pension pot, which they had been banking on, has suddenly halved – it’s painful.

In recent transactions, I have had to compromise. The timing was right so I have offered to buy a stake in the business and create a formula that provides upside in the future subject to performance.

In this marketplace, vendors who want to take money off the table have got to think long and hard in terms of the timing, as to whether it’s going to be a partial sale or a 100 per cent acquisition.

Hold on to cash, it’s king – Nic Humphries – CEO and head of TMT, HGCapital

I think the starting point to get deals done from a private equity point of view is to use available capital to invest. Some firms have invested all the capital they have access to or haven’t raised any new funds. If you haven’t got capital, it’s a pretty bad start for investment. When the markets are down, cash is suddenly scarce so you need ready cash to be able to clear deals.

Typically, private equity funds reserve around 15 per cent of their funds at the end of the fundraising to support their portfolio companies. With our last fund, which raised £950 million, we took the decision last year, in consultation with our investors, to reserve 30 per cent as the recession was looming. We held on to the capital in order to support our platform acquisitions with bolt-on deals, which are a core part of our strategy. Ready cash always helps when people are selling up. In the past, vendors may have debated earn-outs or share exchanges, but actually having cash helps us a lot as people are often selling for liquidity reasons and want the cash.

Another way to get deals done in this climate is to spot businesses that have fundamentally strong growth prospects. When you identify these kinds of companies, then you can back them with all-equity deals. This is because you don’t need to put debt into them because returns will come from the business structure, not the financial structure.

Square the circle with share deals – Mike Taylor – CEO, Innovise

The key thing in businesses worth £5 million to £10 million is that they rely on the quality of their senior management. I don’t think you will find a business of this scale where you can genuinely say that the individual vendors, or the directors, are no longer important.

Once the strategic fit is there and the numbers stack up, either the acquired company is already making money or there is scope for it to make more money through synergies and economies of scale within the expanded enterprise.

It is about the management team, their aspirations and why they are selling – I think this is critical to acquisitions.

If a transaction is going to be funded in large part by shares, the motivations of the directors are critical. In essence, when you say, “let’s do a deal in shares”, you are effectively saying, “defer your exit and align your plans with ours”. If you have got someone looking for a retirement sale, I don’t think you will get much interest in a shares-based deal unless it is the only deal that can be done. They will want to exit at the time of sale and they will want cash.

A shares-based deal will appeal to someone who is coming to the sale because they have hit a glass ceiling. In my experience within the IT services sector, this tends to happen when businesses reach values of around £2 million, £5 million and £10 million.

At these stages, the management team may either have had enough or need additional infrastructure to take the business to the next level. In this case, shares deals make sense because they provide a fresh source of motivation to the management team. The buyer also mitigates the risk. A lot of value can be tied up with the vendor, their knowledge and skills, and if these are not transitioned smoothly and effectively into the enlarged organisation, then the value of the acquired business can be severely reduced.

You live and learn as you go through acquisitions. I prefer to look at deals with a share component somewhere between 25 per cent and 50 per cent – unless it’s a retirement sale. This is about the right level to incentivise the team and goes some way to addressing the risk and reward balance between buyer and vendor. This way, the vendor secures some cash immediately for all their hard work in building the business. However, they still have skin in the game to stay interested in its future performance.

Go back to basics – Bob Holt – CEO, Mears Group

It’s always important not to rush into a deal and be able to walk away if it’s not the right one. Like life, sometimes you get caught up in the moment, but I’ve walked away from thousands of deals in order to consider hundreds.

Just because prices have come off, bad companies don’t suddenly become good ones. I don’t think people should be flattered by acquisitions, and often they are hooked by a cheap price. Buyers need to be as scrupulous as always and this means doing their homework, researching the sector and conducting due diligence on the management. I would recommend staying close to your advisers and giving them a clear brief on the requirements.

In this market, distressed assets are an option, but I would only buy them in sectors that I know extremely well. We recently bought housing maintenance business 3C on an earn-out. It was a £5 million deal, but I still carried out the same due diligence that we would have done on a larger one.

Expand overseas with less risk – Peter Martin – CEO, Tribal Group

The acquisition of a majority stake in consulting business Helm was driven by our strategic wish to develop our business internationally, having historically been focused on the UK.

We wanted to grow our overseas business in order to diversify and because we felt we had specific skills and expertise that were exportable.

Northern Ireland-based Helm works for the major international donor organisations, such as the World Bank, and undertakes public-sector programmes in Asia, Africa and central Eastern European region. We saw opportunities not only to grow that core business but also to sell in our other capabilities, particularly in health and education.

The Helm deal gave us a footprint as over 60 per cent of their revenue is derived from their international work.

The fact that Helm had a UK management team also facilitated the integration process. We would not rule out making an acquisition of an overseas business, but it would need to be in a market with which we were already familiar. For example, we are likely to open an office shortly in Australia (around our health and education business) and, once we get to know the market, we may decide to make an acquisition out there. However, it is highly unlikely that we would go into a country we didn’t know anything about and acquire a business.

Be choosy about the right business – Ken Lindsay – Director, ECI Partners

In the last three months, we have completed three bolt-on acquisitions for investee companies, and are actively pursuing several others in the UK and around the world.

Two lessons stand out from our recent experience. Firstly, it’s even more vital in the current climate to pursue only the best acquisition targets for your business. Be extremely selective – there must be a strong commercial logic for the deal and the combined business has to deliver synergy benefits in reality, not just on a spreadsheet.

Don’t be tempted to buy a business just because it appears cheap – acquisitions are risky at the best of times, but get one wrong in a recession and you may not get a second chance. Choose your targets carefully and wisely.

Secondly, bolt-on acquisitions can definitely still be completed, but expect it to be challenging. Debt is available for the right deals, but the banks will insist on more equity than was the case even 12 months ago (and you will find yourself agreeing to more onerous covenants and pricing on existing debt into the bargain).

Due diligence on any target businesses in this economic climate is certain to throw up some unpleasant surprises. But don’t be put off. Despite these challenges, there are some great opportunities for bolt-on acquisitions being thrown up by the global economic climate. Be very careful, be very certain, and you can be bold.

Deliver long-term value – Alastair Smith – CEO, Avacta Group

Generating significant value from acquisitions in the downturn is less about fixed and operating cost synergies or economies of scale and more about how the skills, expertise and intellectual property of the two companies can be leveraged to improve processes or competitiveness of each other’s business.

Some value can always be created relatively quickly through cost savings identified by the financial functions, but real value that grows over time and feeds itself is more difficult to find and requires some innovative thinking and a detailed understanding of both businesses.

The model we are using to boost the sales revenues and margins of a recently acquired veterinary diagnostic services business is a good example. This involves harnessing the capabilities of our biopharmaceutical operation to streamline the delivery of the existing tests and provide new diagnostic services, while also developing disposable point-of-care screening tests that will drive upselling of comprehensive diagnostic services.

Seeking this sort of long-term value should drive acquisition strategy in the downturn and, if it does, then the benefits are bound to follow.

Nick Britton

Nick Britton

Nick was the Managing Editor for when it was owned by Vitesse Media, before moving on to become Head of Investment Group and Editor at What Investment and thence to Head of Intermediary...

Related Topics