Private equity has the capacity to be of enormous benefit to the right type of business – one that is strong, fast growing and entrepreneurial and poised for significant growth. In a market where the funds available for private equity houses to invest exceed the number of good-quality investment opportunities available, management teams are increasingly able to exert an element of choice over the private equity backer – although it is more likely in a secondary buyout, given that the management has already experienced at least one buy-out, and that they will have a successful track record prior to the secondary buy-out.
‘In general, the first time round with a management buy-out you are just trying to raise the money and don’t tend to consider choosing between backers; with a secondary buy-out it is definitely more of a beauty parade. You are aware that you will have to work with the private equity house, and you need to feel comfortable with them, they will be sitting at your board table for several years,’ according to Terry Norris, who led a management buy-out at discount book retailer The Works in 2003, and was non-executive chairman there until it was bought by Hermes Private Equity in a secondary buy-out in April 2005.
The ‘secondary buy-out’ is a more recent feature of the maturing private equity market – where the private equity house which backed an earlier buy-out is enabled to exit its investment by selling its stake to another private equity house. Secondary buy-outs often provide fresh stimulus to the business with new capital and often one or more new non executive directors who are frequently a valuable source of contacts and knowledge to the management team.
‘In 2003 the management team at The Works had been trying to buy the business for a year, and the vendor had been trying to sell for eighteen months,’ Norris says. Their advisors contacted Norris because of his extensive experience with retail roll-outs. “I looked at the opportunity and couldn’t understand why they had been struggling to complete a deal. I met the company and it was agreed I should become chairman elect, take the deal out of Birmingham and bring it to London to make a fresh start. Chris Maddox, the managing director, and I planned to present to several – five or six – venture capital firms.
‘Primary Capital (the eventual investors) showed tremendous enthusiasm from the first time we met, and we had a second meeting with them before we had presented to all the other potential VCs. We received two offers almost immediately, and I’m sure we would have had a third, except that Primary Capital moved so quickly that the others were left out in the cold. What helped was Primary’s huge enthusiasm from day one, and also that they accepted the management team’s business plan as it stood. We were delighted to get such a good reaction – we weren’t really thinking of selecting a venture capital backer, but just getting the deal done.
‘Graham Heddle from Primary Capital had led the deal, and then joined the board as their special director. He was continually enthusiastic about The Works – each time he visited a store he came out with armfuls of books,’ Norris says.
Enthusiasm and rapport were major factors in choosing a private equity backer for the management team of Robinia Healthcare, another recent buy-out. Founded in 1995, Robinia is a fast growing organisation specialising in residential support services for adults and young people with learning disabilities. In 2003 Bridgepoint Capital funded a management buy-out valued at £50 million, which enabled the business go through a period of highly successful growth, taking advantage of much greater government and societal emphasis on care of the disadvantaged with a policy of providing responsive, high quality services that cater for the needs of individual users.
By 2005 the company’s founder, Elizabeth Wagstaff, decided to retire as chief executive and to realise her equity in the business. ‘The only way Bridgepoint could re-finance was through a secondary buy-out,’ says current CEO Glen von Malachowski.
He led the process which resulted in a secondary buy-out in which Barclays Private Equity and Lloyds Development Capital collaborated to provide £80 million funding to acquire equity from Bridgepoint. ‘We did something like eight presentations to potential backers. The question was did they have the knowledge of the market – if not, we would have to spend too much time explaining things; and did they have the affinity for what we did. Some of them believed that they did, because they had invested in providers of care for the elderly – but they were miles away from understanding what we do. It’s like a doctor and a dentist – they are both in the medical sector, but in detail there is a world of difference in what they do,’ says von Malachowski.
‘It was a very stressful and demanding process. There has to be a rapport, a chemistry between the management and the backer; we needed to feel that we could get on with them and they would be straightforward with us. Some people did try to influence us in ways that were not very professional.
‘With a couple of exceptions who were particularly mean with what they offered, most of the potential backers put forward a financial offer that was in line with market norms at the time. The real differentiator was their negotiating stance, which we thought was a good indicator of what a future relationship would be like. One equity house we considered said they were quite happy to talk about xyz for as long as we liked – but at the end the answer would be ‘no’! We paid a lot of attention to their style, stance and attitude – how well they picked up on what was important to us and how honest they were about what they could offer.’
Malachowski and the management team quickly warmed to the Barclays and Lloyds teams. ‘They both had previous investment in the care sector, and they were responsive, dynamic and aware – they have proved to be terrific partners,’ he says. ‘They stood out a mile. Their standpoint was to put the quality first, then get the business, and only then to look at cost controls to get the required profit levels.’
‘Their value base was synonymous with our own, and they also showed a knowledge of the value base of the care sector – the language and values, attitudes to disability and disadvantage and those historically marginalised. Combined with their business acumen and their previous experience, it was a winning formula.’
Ultimately, the value you get from PE investment is not about cash – it’s about relationships, experience and the depth of involvement you require. What distinguishes one bag of money from another is the equity house’s ability to develop a rapport with the management, to display knowledge of the business and the sector, and to convince the management that they will play with a straight bat in the years ahead.
This article was originally published in Masterclass magazine.