Recently a number of high profile retailers have been acquired by private equity ("PE") houses demonstrating a renewed interest from PE in retail businesses. Most notable amongst these acquisitions are Hobbycraft which was acquired by Bridgepoint for in excess of £100m, Pets at Home which was acquired in a secondary buy-out by KKR for £955m and Cath Kidston which was acquired by TA Associates for £100m.
Given that PE houses raised a substantial amount of capital prior to the credit crunch which reportedly remains uninvested, this trend is potentially good news for owners of retail businesses who are examining their growth and/or exit strategies.
If you are the owner of a retail business looking for additional investment or a management team interested in acquiring a retail business from its current owner (whether that be from a founder who is looking to exit or a large conglomerate looking to sell non-core assets) what actions should you be taking and what issues should you be considering before seeking PE backing?
What is the PE house looking for?
The PE house will be looking to invest in companies which have:
· a strong management team with the abilities and desire to grow the business;
· a proven track record;
· strong cash-flow;
· growth opportunities;
· a unique selling point – something that gives the company a competitive advantage, such as a strong and emerging brand or a unique product; and
· a strong business plan.
Different PE houses invest in deals of different sizes and many focus on specific sectors. You should therefore investigate which PE houses invest in the retail sector (such as Graphite Capital Management, Primary Capital or ISIS Equity Partners) and in businesses of a similar size to yours so that you know who to target.
At this stage and as part of this exercise it might be prudent to talk to corporate finance advisors who will be familiar with these types of funders.
Preparing the business for a buy-out
Business planning: You should review your current business plan or, if you do not currently have a business plan, create one. Again a corporate finance advisor can help you get your business plan into the form expected by a PE house but, as a starting point, the BVCA has published a useful guide which sets out the areas your business plan should cover and which is available here. Be aware that drafting and updating a detailed and robust business plan can take a considerable amount of time. In addition the PE house will expect the management team to be willing to stand by the business plan so you should ensure that it is based upon reasonable assumptions and sensitivities as to its achievability.
As you will need to present your business plan to the PE house, it is essential that each key member of the management team understands the business plan and can present it confidently. You should also identify where there are gaps in your team's expertise and be able to explain how you propose to fill them, for example, does a member of the team have the necessary financial expertise to carry out the role of finance director or do you need to recruit one?
Due diligence: As part of the acquisition or investment process a PE house will carry out due diligence seeking to identify any issues with the business which could affect its future growth or profitability and to confirm that the business is worth the valuation it has placed upon it. This process will typically include commercial due diligence on the markets in which the business operates carried out by market specialists, financial due diligence carried out by their accountants and legal due diligence carried out by their lawyers. It is therefore helpful to carry out your own mini-due diligence process early on in order to anticipate and identify where there are potential weaknesses or issues for attention prior to approaching any PE houses.
Operational Aspects: You should consider the strengths and weaknesses of all aspects of the business including:
· Who owns the intellectual property used in the business? For example, if the business' brand name has been registered as a trademark, in whose name is the trademark registered? Who designed the company's website? Did that person validly assign all intellectual property in the website to the company? Are there any intellectual property rights that are not currently registered but which should be?
· What is the condition of your real estate portfolio? The nature of your business will affect how important the premises you operate from are to the business. Assuming the sites are important to the business you should review the terms of the leases for instance to understand which expire in the short term or whether they contain any particularly onerous terms.
· Do you have written agreements with all of your key suppliers? If not, take steps to put contracts in place and take legal advice when negotiating these contracts to ensure none of the contracts contain unusual or onerous terms.
· Assuming you sell products via your website, are the terms and conditions of sale validly incorporated when customers purchase products online? Are there any terms which you might struggle to rely on, for example because they are unfair on the consumer?
· Whether your financial reporting systems are fit for purpose. The PE house will not only be looking for comfort that your historical figures are accurate but will also require management accounts and other financial information to be provided to them on a regular basis and in a timely fashion following the buy-out. Do you have the systems in place to be able to deliver this?
· Do all of your key staff have written contracts of employment? If not, consider putting written contracts in place. You should also check whether you are compliant with all applicable employment legislation, for example, the business should have formal disciplinary and grievance procedures.
· Are you currently engaged in any material litigation (other than debt recovery in the ordinary course of business)? Make sure you have all pertinent information available and can be as open and honest as possible about the litigation and the company's potential liability.
The PE house will expect the management team to make or continue to have a personal investment in the business. This ensures an alignment of interests between the management team and the PE house as any increase in the value of the business will be of mutual benefit.
As a manager seeking PE backing you should consider how much you would be prepared to invest and how you would fund such an investment, particularly if you do not already have equity in the business. There is no hard and fast rule for how much the PE house will expect a management team to invest and what percentage shareholding the management team will be offered. This will typically depend upon the importance of each manager to the business, the financial resources of the managers and the size of the business.
ConclusionYou should start considering the factors set out above as early as possible to ensure that everything is in order before you approach different PE houses for backing. The next step in the process once you have identified the PE house you wish to invest with will be to negotiate the terms of on which the PE house and management will invest in the company. This typically covers matters such as to what extent the management team can make decisions without reference to the PE house, in what circumstances a manager can be forced to sell his shares (and at what price) and the PE house's right to board representation. These matters will be considered in the next edition of Talking Shop.