Private capital markets have outperformed public equities in recent years, leading to an increase in asset allocation to private capital classes in Australia.
Whilst M&A transaction volumes have remained depressed post-COVID-19, there remains a significant amount of ‘dry powder’ in the private equity sector waiting to be deployed. There are signs of green shoots in the Australian market as some of the uncertainty which has been plaguing the M&A market, including interest rate movements and geopolitical tensions, starts to dissipate. This should lead to greater opportunities in the coming year for quality assets to attract capital from private equity sponsors.
So what does it take to sell your business to private equity? We highlight the 7 key steps you need to be aware of, and prepared for, below.
1. Picking the right advisers
The first step in any sale process is engaging advisers who are well equipped to advise on the lifecycle of the transaction. This is particularly important in circumstances where the prospective buyer pool is likely to be dominated by private equity.
There are certain complexities associated with transactions involving private equity buyers that make it critical to engage lawyers and financial advisers who understand private equity deal structures.
Corporate advisers also play a critical role in marketing a target company and providing access to potential bidders. Different corporate advisers specialise in different segments of the market and have access to different pools of buyers. It’s important to understand the differences and find a corporate adviser who will be able to maximise deal value and manage deal execution.
2. Vendor due diligence
In a competitive sale process, a seller will need to consider whether to conduct ‘vendor due diligence’ on the target group.
In the current market, most private equity buyers will not agree to incur the cost of undertaking due diligence until they are granted exclusivity. The strategy behind undertaking vendor due diligence is to give interested parties sufficient information about the target group to make a bid without incurring material expenditure. This may lead to an increase in the number of bids received and help build competitive tension.
Although conducting vendor due diligence results in diligence costs being borne by the seller (rather than the buyer in a bilateral negotiation), it also allows the seller and its advisers to identify and mitigate any potential issues before the sale process commences.
3. Non-disclosure agreements
Once your corporate adviser has prepared a teaser and information memorandum, the target group or seller will enter into non-disclosure agreements (sometimes also referred to as confidentiality agreements) with interested parties. These agreements are important for protecting the confidential information of the seller/s and target group, particularly where bidders may be competitors of the target.
Private equity investors are more likely to require amendments to any pro-forma NDA and often have their own in-house position on various issues that arise in an NDA. This is particularly important for private equity funds because they look at a broad range of opportunities and therefore enter into a significant number of NDAs. For example, private equity bidders typically insist on the inclusion of ringfencing provisions which acknowledge that the provisions of the agreement do not apply to other parts of the relevant private equity group.
Once non-disclosure agreements have been agreed upon and entered into by the relevant parties, the bidder will be provided access to the data room in order to review due diligence materials and decide whether to submit an offer.
4. NBIO phase
Corporate advisers issue process letters to interested parties setting out how the sale process will be conducted. Process letters usually call for submission of non-binding indicative offers (NBIOs) from bidders outlining their initial offer to acquire the relevant target group. The NBIO is used to establish the key terms of the offer from the interested party and will usually be subject to due diligence.
Corporate advisers then go through a process of evaluating bids and shortlisting interested parties. In order to maintain competitive tension, corporate advisers will often encourage short-listed parties to submit a best and final offer or even seek to negotiate transaction documents with multiple bidders. As noted above, mid-market private equity sponsors, in particular, will usually be reluctant to spend money on undertaking due diligence and negotiating transaction documents without exclusivity.
On signing a NBIO with a preferred bidder, the seller will provide the relevant bidder with exclusivity for a defined period (usually anywhere from 6 weeks to 3 months, depending on the nature of the transaction) to enter into binding transaction documentation.
It is important that the terms of the transaction are clear in the NBIO to avoid disagreement between the parties on key deal terms during negotiation of the binding transaction documentation.
5. Sale and purchase agreement
A legally binding sale and purchase agreement (SPA) will be negotiated between the seller and the preferred bidder (which will ordinarily include input from legal, financial and tax advisers). It is important that the seller (and their advisers) understand the complexities of common private equity deal structures including rollovers, earn-outs, completion accounts and associated adjustments.
The warranty regime and associated liability for the seller/s is also critical for the seller/s to understand before entering into a transaction. A seller needs to understand how these issues ultimately affect the final proceeds they receive for the transaction.
6. Shareholders agreement
It is common in mid-market private equity for a private equity sponsor to acquire control of a target group, but for some or all of the existing shareholders and/or management to retain a minority shareholding in the target. This means that the buyer and continuing shareholders need to enter into a new shareholders agreement which governs how the Company will operate post-completion.
Some key considerations to be cognizant of in the shareholder’s agreement include:
- Board composition – including appointment rights, voting thresholds and quorum for meetings – it is important for sellers to ensure that an acceptable level of control is maintained which can be achieved, for example, by ensuring that the sellers’ approval is required in order for certain decisions to be made/resolutions to be passed;
- Pro rata issues of shares – including that any issue of new shares must first be offered to existing shareholders on a pro-rata issue of shares, which will help minimise any dilution (which may impact control of the company);
- Transfer provisions – including restrictions on transfer, as well as appropriate drag-along and tag-along thresholds;
- Exit provisions – the rights of the private equity sponsor to require an exit (sale or IPO); and
- Leaver provisions – particularly focusing on the definitions of ‘good leaver’ and ‘bad leaver’ which will govern circumstances where employee shareholders exit the company.
7. W&I Insurance considerations
Warranty and indemnity (W&I) insurance is becoming an increasingly common part of Australian M&A transactions, particularly those involving private equity investors.
Whilst these policies may be procured by either a buyer or a seller, most of the W&I policies in Australia tend to be buy-side, which provide the buyer with recourse to the insurer for breach of an insured warranty or indemnity in the sale agreement by the seller.
At the start of a sale process, the seller will usually work with a W&I insurance broker. The insurance broker will obtain quotes and terms of coverage from various underwriters, review seller (legal and financial) due diligence reports and the draft sale agreement and provide indicative terms for coverage which will be provided to prospective bidders. The successful bidder (who will later become the buyer) will then work with the insurer to ensure that the selected insurance policy is in place at the time of the relevant transaction.
Premiums can be paid by the buyer or seller, or sometimes both, but this often forms part of the price negotiations between the parties to the transaction. It is important for sellers to consider (in discussion with corporate advisers), on balance, the benefits of incorporating W&I insurance into a proposed transaction. This will require discussions with advisers and the buyer as to whether it is appropriate and will largely depend on the nature of the transaction.
There are many benefits of incorporating W&I insurance into a transaction. It allows for a clean exit for the seller/s and gives the buyer greater certainty in relation to their investment being kept whole. Some other benefits of W&I insurance include:
- Multiple sellers – W&I insurance could alleviate concerns that a buyer has in relation to its ability to recover on a warranty claim against multiple sellers;
- Credit risk – this may remove the need for any escrow arrangements or deferred consideration as it may provide a buyer with greater confidence; and
- Management/founder shareholders – in circumstances where a seller/founder may remain employed by the relevant target entity post-completion of the transaction, W&I insurance may provide the buyer with comfort that, in the event of a warranty claim, it can make a claim directly with the insurer and preserve the relationship with the seller/founder.
Considering selling your business?
There are many potential benefits to running a competitive sale process. Sellers and advisers need to consider several factors when starting a sale process, beginning with engaging the right team of corporate, legal and financial advisers. These advisers will need to be experienced in negotiating through the critical phases of the transaction including the NBIO, final offer and the substantive transaction documents (such as the sale agreement and shareholders agreement).
Hamilton Locke has advised on both the buy-side and sell-side of numerous private equity transactions and is well placed to advise owners on the full lifecycle of a transaction, from initiating a competitive sale process through to completion and beyond.
For more information, please contact Peter Williams (Partner), Benny Sham (Partner) and Grace Kaggelis (Senior Associate).
