By-Lined Article
The Finish Line: Financing the Deal and Selling It Upstairs
By Duane Morris Private Equity Connections
Summer 2012
Duane Morris Private Equity Connections
For all the dry powder waiting on the sidelines, most deals still require financing and approvals from boards and lenders. Strategic investors have the advantage here—they can tap balance sheets and lines of credit. Sponsors rely disproportionately on leverage, which means added financing contingencies and uncertainty for sellers.
Once a company has committed to a sale, settled on a price and put itself through the diligence gauntlet, few things matter more to a seller than closing the deal as quickly as possible. Beyond the pricing and the structure of a deal, sellers will favor bidders who can offer some certainty of closing—the fewer contingencies, the better. Financial sponsors must arrange debt financing, a process that takes time and adds uncertainty to any deal. For strategic bidders, waiting for approvals from an indecisive or micromanaging corporate board is something most sellers would like to avoid.
On some counts, corporate dealmakers face a level of bureaucracy unknown to financial sponsors. They must resolve a myriad of integration details with any department that might be affected by a merger. "Bigger deals will need to go before the board of directors before the acquisition can close. Selling the deal internally can be just as difficult and time-consuming as negotiating terms with the seller," says Chang of UPS.
Voorhees at RockTenn finds that communicating early and often is better than waiting for a quarterly board meeting for approvals. "We'll typically communicate throughout the process," he says. "We can always get on the phone with our CEO if we are working on a deal." RockTenn is conscious of its reputation as a responsible acquirer. "If we're buying a company, it is important for us to be comfortable with each other. Part of that is being responsive as issues come up," he adds.
"If we're buying a company, it is important for us to be comfortable with each other. Part of that is being responsive as issues come up. . . . We'll typically communicate throughout the process." Steve Voorhees, RockTenn
Financial sponsors have a reputation for being faster off the mark when it comes to signing off on a deal. The main business of a private equity firm, after all, is to buy and sell companies; approvals usually proceed with little delay.
At Riverside, every deal goes before the firm's investment committee, which includes most of the firm's partners as voting members. Ibrahim says there are three levels of approval: 1.) an initial approval to release a letter of intent, specifying the terms of the offer; 2.) a mid-course approval where documents are submitted to the committee and the deal team has a chance to respond to any outstanding questions; and 3.) a final approval to release funds to close the deal. "They are formal milestones," says Ibrahim. "We usually communicate informally with the investment committee on a weekly basis."
Financing Can Tip the Scales
If sponsors have the advantage of a smoother approval process, strategics have the advantage when it comes to financing a deal. More-robust balance sheets and less reliance on leverage mean greater certainty that a deal will close. Strategic buyers can finance smaller deals with existing lines of credit or pay cash. Depending on the amount involved, they may have to demonstrate to their bankers that the deal will not break any existing covenants and also prove to their boards that financial risk is contained. Most larger corporations can absorb the risk and contribute the cash without much disruption.
Voorhees provides insight into how a company such as RockTenn finances acquisitions. The process starts at the earliest stages of negotiations, he explains. "Before we sign a letter of intent, we already know how we will finance a deal." The bigger the deal, the more likely it is to have an equity component. When RockTenn acquired Smurfit-Stone Container last year, "we thought it was appropriate to finance the deal conservatively, by issuing new RockTenn shares in exchange for Smurfit-Stone shares," says Voorhees.
When financial sponsors are competing directly with strategics for the same deal, a financing contingency can be a deal breaker. If bidding is competitive, Riverside will remove financing contingencies if the partners are confident the leverage will be there when it comes time to close. If bankers have been lending 4x EBITDA in similar deals, Riverside will take the risk and proceed with a no-contingency bid before the lender has committed. Ibrahim says that Riverside "has never failed to close a transaction due to lack of financing."
Roark Capital has also removed contingencies to win a deal. "We have existing banking relationships in the sectors that we cover," says Bryant. "We've waived financing contingencies occasionally, which allows us to act more like a strategic as opposed to a financial buyer." This is the exception, rather than the rule. Most private equity bids—especially large ones—come with a financing contingency.
Ultimately, it is up to the seller: Waiting out a contingency may not matter if the terms offered by a financial sponsor make it worthwhile. And a delayed sign-off from a strategic buyer may not matter as much as a higher valuation and a good exit.
The Duane Morris View
Stuart Sorenson: Which way do the cards stack up in the private equity wars? Strategics bring financing certainty; the probability of higher, market-clearing valuations; and formidable resources to move the business forward. On the other side of the ledger, financial sponsors offer flexible structures, including possible ongoing participation; a less draconian environment for valued long-term employees; and potentially more creativity in growing the business. In a dynamic contest, how does a seller evaluate all the variables, not the least of which may be a comprehensive self-analysis into motivation, expectations and vision for the future? Early on in the process, the most vital decision is to identify the right transactional advisors—the right lawyers, the right accounting group, the right investment banker—with the experience and understanding to analyze and define goals. Then, it is essential to craft a process designed to execute against those goals.
