Private Equity Buy Out Lecture Notes PDF

1 Entrepreneurial and Growth Finance Private Equity: Buy out Andrea Tomaschù Managing Director Riello Invetimenti Partners SGR PRIVATE EQUITY: BUY OUT – ANDREA TOMASCHU’ ...

1 Entrepreneurial and Growth Finance Private Equity: Buy out Andrea Tomaschù Managing Director Riello Invetimenti Partners SGR PRIVATE EQUITY: BUY OUT – ANDREA TOMASCHU’ Buy out operations 2 Buy out Buy out Majority Acquisition of a company’s capital PRIVATE EQUITY: BUY OUT – ANDREA TOMASCHU’ Buy out operations - Europe 3 Buy out: data Source: Invest Europe / EDC PRIVATE EQUITY: BUY OUT – ANDREA TOMASCHU’ Italian buy out operations 4 Investments distribution 2014 by Types Source: AIFI-PwC PRIVATE EQUITY: BUY OUT – ANDREA TOMASCHU’ Italian buy out operations 5 Investments distribution 2015 by Types Ammontare (Euro Mln) Numero Amount (€ Mln) Number 3.255 122 101 81 34 894 4 333 74 64 Buy Out Replacement Expansion Early stage Turnaround Source: AIFI-PwC PRIVATE EQUITY: BUY OUT – ANDREA TOMASCHU’ Italian buy out operations 6 Investments distribution 2016 by Types Source: AIFI-PwC PRIVATE EQUITY: BUY OUT – ANDREA TOMASCHU’ Italian buy out operations 7 Investments distribution 2017 by Types Source: AIFI-PwC PRIVATE EQUITY: BUY OUT – ANDREA TOMASCHU’ Italian buy out operations 8 Investments distribution 2018 by Types Source: AIFI-PwC PRIVATE EQUITY: BUY OUT – ANDREA TOMASCHU’ Italian buy out operations 9 Investments distribution 2019 by Types Source: AIFI-PwC PRIVATE EQUITY: BUY OUT – ANDREA TOMASCHU’ Italian buy out operations 10 Investments distribution 2020 by Types Source: AIFI-PwC PRIVATE EQUITY: BUY OUT – ANDREA TOMASCHU’ Italian buy out operations 11 Investments distribution 2021 by Types Source: AIFI-PwC PRIVATE EQUITY: BUY OUT – ANDREA TOMASCHU’ Italian buy out operations 12 Investments distribution 2022 by Types Source: AIFI-PwC PRIVATE EQUITY: BUY OUT – ANDREA TOMASCHU’ Italian buy out operations 13 Average invested amount by type in 2022 Source: AIFI-PwC PRIVATE EQUITY: BUY OUT – ANDREA TOMASCHU’ Italian buy out operations 14 Historical trend of Buy out investments Source: AIFI-PwC PRIVATE EQUITY: BUY OUT – ANDREA TOMASCHU’ Italian buy out operations 15 Distribution % buy out by size Source: AIFI-PwC PRIVATE EQUITY: BUY OUT – ANDREA TOMASCHU’ Italian buy out operations 16 Investments distribution % Initial / Follow on Source: AIFI-PwC PRIVATE EQUITY: BUY OUT – ANDREA TOMASCHU’ Buy out operations 17 Change Financing and Buyout Change financing – An invstment that has the consequence to change the governance and the control structure ▪ Replacement capital ▪ Buy Out Buy out operations affect the Majority of the shares or total control. These operations change the management of the target company introducing new strategies and new managers. Can include expansion operations Buy out is the most relevant category in the Private Equity sector PRIVATE EQUITY: BUY OUT – ANDREA TOMASCHU’ 1 Buy out operations 8 Buy out: Different 18 types (1/2) Management buyout (MBO) This type of buyout is promoted by the management of the target company who usually acquires complete control of the firm. Management buy in (MBI) External managers plan the deal and become shareholders with a considerable quota of participation to obtain control of the company. Buy in management buyout (BIMBO) External and internal managers of the company promote this type of deal. Buy in growth opportunity (BINGO) The value invested by the financial intermediaries exceeds the value of the company to finance its growth. Worker buyout (WBO) Employees enter into the shareholder structure of the target company so the property is enlarged to allow them to take part in the firm’s management. PRIVATE EQUITY: BUY OUT – ANDREA TOMASCHU’ 1 Buy out operations 9 Buy out: Different 19 types (2/2) Family buyout (FBO) Occurs when the company’s proprietary structure is controlled by the family promoter. Investor buyout (IBO) This type of operation is realized by a financial investor, such as a private equity fund, who decides to buy the entire equity of the target company. Public to private (PTP) A way to conclude a buyout by delisting the target company from the public financial market. Revers buyout (RBO) The target company has already been subjected to a PTP and the buyout is concluded with a new quotation of the firm on the public financial market. PRIVATE EQUITY: BUY OUT – ANDREA TOMASCHU’ 2 Financial leverage & leveraged buy out 0 20 LBO: Target companies profile Low current leverage Predictable and strong cash flows Established business Barriers to entry Strong asset base Operational improvement opportunities Growth opportunities Exit options Availability of a strong management team PRIVATE EQUITY: BUY OUT – ANDREA TOMASCHU’ Buy out operations 21 Buy out: Deal Process 8) MONITORING 6) SIGNING 4) NEGOTIATION WITH SELLER EXIT 2) LETTER OF INTENT 7) ACQUISITION & CLOSING 5) NEGOTIATION WITH BANKS 3) DUE DILIGENCE AND ESG VALUATION 1) SCREENING PRIVATE EQUITY: BUY OUT – ANDREA TOMASCHU’ 2 Financial leverage & leveraged buy out 2 22 LBO: Debt Instruments & Stakeholders Debt Instruments Revolving credit facilty Bank debt High – Yeald Debt Seller Notes / Vendor Loan Stakeholders Banks Audit Firms Managers Suppliers Law Firms Clients Advisors Target Shareholder PRIVATE EQUITY: BUY OUT – ANDREA TOMASCHU’ 2 Financial leverage & leveraged buy out 3 23 Leverage effect on Target Acquisition debt is repaid through: Cash flows of the target Disinvestments of non strategical assets The post LBO financial structure of the target company has an influence on its development program, because the company must be focused on the repayment of the acquisition debt until the financial structure is normalized: Growth effect and higher profitability Debt reduction through repayment The Financial structure of the acquisition must not prevent future growth PRIVATE EQUITY: BUY OUT – ANDREA TOMASCHU’ 2 Financial leverage & leveraged buy out 4 LBO: Objectives to achieve before 24 Exit ▪ The critical success factors of LBO acquisitions are a strategy mix of: devolpment, innovation, operational efficiency and rationalisations. ▪ The acquisition don’t involves, normally, new additional financial resources. Acquisition EBITDA Organic growth Increase Efficiency improvements DEBT Cash Flows generated Reduced Equity growth Size increase MULTIPLE Operational improvements Expansion Market timing & Right Exit moment PRIVATE EQUITY: BUY OUT – ANDREA TOMASCHU’ 2 LBO structure 5 Classic Structure 25 The acquisition of the majority stake in the target company is executed through a «newco» company. The Newco buys the 100% of the target shares. The acquisition is financed with a mix of equity and debt. Fase 1: Newco incorporation Fase 2: Newco financing (debt and equity) Fase 3: Payments to sellers Fase 4 (often): Merger between newco and target As a result of the acquisition the target will be more indebted PRIVATE EQUITY: BUY OUT – ANDREA TOMASCHU’ 2 LBO structure 6 Traditional structure 26 PRIVATE EQUITY FUND Price Majority % Founders / Financing NEWCO BANK Managers Minority % 25,0% 100,0% Collateral TARGET Merger Area PRIVATE EQUITY: BUY OUT – ANDREA TOMASCHU’ 2 LBO structure 7 Acquisition & 27 Financing: Contracts Contract set Share Purchase Agreement (SPA) Statute and shareholders agreement (governance rules, way out, tag along-drag along, deadlock situation…) Financing contract and collateral obbligations Management agreements and incentive plan Stock Option Plan Documentation to support the system of representations and warranties PRIVATE EQUITY: BUY OUT – ANDREA TOMASCHU’ 2 Buy out - financing 8 28 Acquisition financing The acquisition financing normally involves two facilities: Senior Debt Subordinated debt The senior lines provides the liquidity needed for the price payment. Main characterstic are: Duration between 5 and 8 years with a Semi – Bullet payment Amortization schedule linked to the cash flows of the target Collateral on manufacturing and estate assets. Subordinated debt proviede additional liquidity for price payment also and/or additional investments and is repayed only after the senior debt full repayment PRIVATE EQUITY: BUY OUT – ANDREA TOMASCHU’ 2 Buy out - financing 9 29 Acquisition financing: Financial Covenants Most relevant financial covenants: EBITDA/NFP Net Financial debt/ebitda (generally < 3,5x - 4,0x) EBITDA/OFN Ebitda/net debt interest (in genere maggiore di 3,0x - 3,5x) DSCR Debt Service Cover Ratio: Free cash flow/debt service ( generally > 1,0) NFP/Equity Net Financial Debt/Equity (generally < 2,0) Excess cash flow: obligation to early repayment of excess cash flows (c.d. cash sweep) Limits on investments above the agreed amount PRIVATE EQUITY: BUY OUT – ANDREA TOMASCHU’  Leverage Buy out – financing & structure 30 An acquisition case Strutturazione dell’operazione di LBO La struttura “classica” PRIVATE EQUITY FUND Price 75,0% € 44,0 mln. € 15,0 mln. The financing bank has a pledge on the shares of newco and target. NEWCO Financing BANK Founders / Managers Equity € 20,0 mln. Senior Debt € 12,0 mln. Equity € 5,0 mln. Senior Debt € 12,0 mln. Earn Out Facility € 4,0 Vendor Loan € 8,0 mln. Debt Earn Out € 4,0 mln. 25,0% 25,0% Vendor Loan € 8,0 mln. mln. € 13,0 mln. The Vendor Loan of € 100,0% 8,0 mln from the founders is normally reimbursed after the Bank Financing and will be repaied in one TARGET Collateral tranche at time of the divestment. MERGER AREA PRIVATE EQUITY: BUY OUT – ANDREA TOMASCHU’