← M&A Talk: #1 Podcast on Selling a Business
M&A Talk: #1 Podcast on Selling a Business
A Private Equity Fund Bought Your Business – What Happens When They Don't Want to Sell It?
00:21:49
When a private equity firm buys your business, what happens if they don’t want to sell it before their fund ends? This episode dives into continuation vehicles, a tool firms can use to extend their ownership of your company. We’ll explore how...
Loading summary
Transcript56 lines
- [00:00]
A
Continuation vehicles are essentially a new technology in the private equity space. I say new, but it's probably been around and been used in earnest for the last four or five years. When it works, the private equity sponsor obviously is very eager to sell that company into a an active M and A market itself and hopefully books a gain. Hopefully that gain is in the carry and the system works.
- [00:23]
B
Welcome to M and A Talk, the number one podcast on all things related to mergers and acquisitions, brought to you by Morgan and Westfield, a nationwide leader in mergers and acquisitions for small to mid market companies. We bring you exclusive interviews with industry experts in business sales, valuation, private equity, investment banking and more. It's our mission to provide you with insight and guidance on how to build your company's bottom line and maximize value for eventual sale. Here's your host, Jacob this is your.
- [00:56]
C
Host Jacob Oros and President and founder of Morgan and Westfield, a boutique M and a firm specializing in the sale of small to mid sized companies. And if you do own a small or mid sized company, if you're considering selling it, and if you'd like to work with me throughout the process, you can schedule a free consultation@morganwestfield.com or if you'd like us to perform an assessment and valuation of your company, I'll have a link to that information in the Show Notes. There's a very nominal fee, there's no commitments, there's no contracts. It takes us two weeks to do and I'll have a link to that full information on that process in the Show Notes. If you own a company and if you'd like a copy of one of my two recent books, the Art of the Exit, which is written for companies with 1 to 10 million in revenue or acquired, which I wrote for companies with 10 to 100 million in revenue. If you'd like a copy of one of those books and you own a company, I'd be happy to send you out a copy. Just send an email to podcastorganwestfield.com or we'll have our contact information in the Show Notes as well. Now onto today's show, we're going to talk with Jeff Bollerman. He is in the Private Capital Advisory Group at Raymond James and we're going to talk about a somewhat complex topic which is a continuation vehicle. But you as a seller, what you really need to know is if you sell your company to a private equity firm and they buy your company, what happens if they cannot or do not want to sell your company before their fund life terminates? Because as we know, private Equity firms have funds and those funds have definite termination dates or they're very often 10 to 12 years long. And if that private equity firm cannot or does not want to sell your company before that fund terminates, what happens? And that's exactly we're going to talk about today. And Jeff, welcome to the show.
- [02:54]
A
JACOB thank you for having me again. It's nice to join you.
- [02:57]
C
So we're going to talk about what happens if you sell your company to a private equity firm. And as we know, many times they have a fund life cycle and they aim to sell your company within that fund life cycle. What happens, Jeff, if they cannot sell your company before that fund terminates?
- [03:18]
A
JACOB that's an excellent question. And just to back up even further, what would most people expect when they sell their company to a private equity fund? And certainly what a private equity fund expects when they buy a portfolio company is that they will hold it for a certain amount of years in the beginning and feed it and apply growth and venture capital to that new acquisition and fund, the founders and the management's view for the future success of that company. And sometimes it works and sometimes it doesn't. When it works, the private equity sponsor obviously is very eager to sell that company into an active M and a market itself and hopefully books a gain. Hopefully that gain is in the carry and the system works. But there are situations where that doesn't happen sort of as smoothly, right? You may imagine a scenario where on the good side, a private equity sponsor purchases a portfolio company and that portfolio company goes gangbusters and it grows dramatically and becomes a wild success and actually becomes a useful place to deploy significant amounts of capital. As you can imagine, the way private equity funds are structured, they don't have infinite amounts of capital to deploy into a single portfolio company. In fact, many times they're limited to how concentrated they could be in any one portfolio company. That might be an instance where you think, okay, everything is going well, but the thesis for the private equity fund when they bought the company is actually outperforming. In that scenario, you may be prematurely sold by private equity sponsor not to a new buyer, but essentially to itself.
- [04:53]
C
And that's a continuation vehicle.
- [04:55]
A
That would be one of the use cases for a continuation vehicle. JACOB Absolutely right.
- [04:59]
C
How do they do that? How do they sell it to themselves?
- [05:01]
A
So what they would essentially do is hire an investment banker. That investment banker will run a robust process and conduct price discovery. And to the extent that secondary investors, private equity funds that are formed strictly to buy the limited partnership interests and the Portfolio companies of existing private equity firms would develop a price. That price would then go to the limited partners of the existing fund and say, look, the secondary investor is willing to buy this single portfolio company for enter the price. The price is often quoted as a percentage of navigation.
- [05:35]
C
Now is that just of one portfolio company, though it could be a single.
- [05:37]
A
Portfolio company which would be a single asset continuation vehicle, or it could be more than one which would be a multi asset continuation vehicle. For the sake of simplicity, let's just complete the thought. On single asset continuation vehicles, the new investor would develop a price. That price is often quoted as a percentage of NAV, oftentimes upwards of 90 plus percent. And then you would go to the existing holders and say do you want to accept liquidity, I. E. Sell your company to these new investors or do you want to roll and basically continue to participate in the life of the portfolio company for the next chapter? That next chapter will be the incumbent fund. The incumbent GP will continue to manage the fund, although with new investors, the secondary private equity investors and others. And essentially what that seeks to do is extend the shot clock that the private equity firm has with the company. They will then hold it for another four or five years and then exit. When the company continue to invest in the company, they will get fresh capital to deploy into the company. And it's essentially a private equity fund with a single portfolio company and a handful of new investors. That's use case number one. Use case number two is less optimistic, right? You can imagine a private equity fund gets raised, let's say it buys 10 or more companies and it exits those companies in the ordinary course. Inevitably there will be some portfolio companies that reside in the fund that have not been sold. Because maybe the investment thesis has not turned out the way the general partner had wanted it to. Maybe there has been, it's just simply been a laggard. So it will grow, but it hasn't grown sort of in time to sell at the end of the private equity fund's life cycle. So in that case, there may be one or two or a handful of assets that, that a general partner might elect to put into a continuation vehicle, essentially as a cleanup trade. So in that scenario, it's the same documents, it's the same dynamics. You also need to hire a third party investment banker to run a robust process. There may be a rationale why the GP may be the optimal decision for the GP to continue to hold that company for reasons that they will have to defend, in which case they will run a process, get pricing that pricing may not be as high as it would be for a healthy performing company that's bursting at the seams. These are older portfolio companies. They would price perhaps less aggressively, but again, it would put more time on the clock for the investor, the general partner, to deploy into those companies and it would allow them to essentially defeat and shut down the prior fund. So that's sort of a cleanup trade.
- [08:13]
C
What's the earliest this could happen from the closing? So, say a private equity firm buys a company, could this happen within three, four years of that closing?
- [08:21]
A
It could absolutely happen within three.
- [08:23]
C
Depends on when that fund terminates. Correct.
- [08:25]
A
If the continuation vehicle happens in anything other than the later innings in the life of the fund, it's probably because the portfolio company itself is growing so much, it has such a demand for fresh capital and a use case for fresh capital that they're looking to essentially sell it to a new vehicle also managed by the gp, that the existing investors could very well continue to ride along with, in which case they will roll into the new continuation vehicle. Or they may say, look, this company is valued at 2, 3, 4 times what the general partner originally purchased it at. I'm happy with these gains. I don't need more incremental gains. So I will happily take the liquidity today and give up whatever upside the continuation vehicle might gain for the next chapter.
- [09:10]
C
Why do they need to hire an investment banker if they're selling it to themselves?
- [09:14]
A
I think it's become a best practice and I think for very good reason. If you think about the general partner, they are both buyer and seller.
- [09:22]
C
It's a conflict of interest for their investors.
- [09:25]
A
Absolutely.
- [09:26]
C
To reduce conflict of interest, to ensure that they're paying an appropriate price.
- [09:30]
A
Jacob? That's exactly right.
- [09:32]
C
Does the investment banker disclose that to the potential buyers out there?
- [09:36]
A
I think given the nature of the transaction, it's just that conflict is inherent and any participant in this market will understand that the GP is both on the buy side and the sell side. What is the most critical part of these transactions is when the banker speaks to the lpac, the limited partner advisory committee of the prior fund, to essentially describe how robust the process was, describe price discovery and how we went about it, and ultimately to help to clear.
- [10:05]
C
The conflict, to ensure a lack of conflict of interest.
- [10:09]
A
Exactly, exactly.
- [10:10]
C
Does this cost the seller anything? So if the seller rolls over some equity, keep some equity in that company, does this cost the seller anything to continue the ownership under the same firm?
- [10:20]
A
So it's interesting. So there are any number of sellers. I mean, in one Respect. The seller is the general partner. In other respects, the sellers are the limited partners who are accepting the new liquidity.
- [10:32]
C
What about for the original founder of the company that had sold the company to the private equity firm and is now staying on, say that they rolled over some equity into that company. Would it cost them anything?
- [10:43]
A
Let me answer the first question because that's an interesting question, Jacob, about the incumbent seller. So the seller, to the extent that it's the general partner, does not pay anything. The fees and expenses, so there are legal expenses, et cetera. And then the advisory fees are borne by those limited partners that elect to accept the liquidity. So they do the transaction to the extent that it is exercised. The optional liquidity. Those fees and expenses are essentially borne by the limited partners who are selling. So it's sort of netted out of their sale proceeds. But you asked a very good question regarding the founders of the companies who had originally sold the company to the private equity firm. To the extent that those founders and that management team is still going to be the management team for the next chapter in the company's life, it is strongly expected that they will roll their exposure into the continuation vehicle. So it is often not a liquidity event for existing management. It's not a liquidity event for the selling general partner. They are rolling all of their carry into the new continuation vehicle. It is a liquidity event. Obviously to those who elect the optional liquidity and sell, it could be a liquidity event for folks who maybe have retired either from the general partner or from the management of the company. If you are not an integral part of the next chapter in the company's life, you can view these transactions as an opportunity to realize your investment. But if you have anything to do going forward, you are fully expected to continue to roll with the company.
- [12:14]
C
Do we have any statistics on how often this happens to where private equity firm buys a company and they just can't sell it within that fund's timeline?
- [12:23]
A
We do have broad level data on the secondary market generally. Right. So the secondary market in this year could very well top $200 billion.
- [12:32]
C
For those that don't know the audience, what's a secondary market market?
- [12:36]
A
So the secondary market for private equity is essentially the billions and billions of dollars that have been organized to do one of two things. One? Well, actually more than two things. But the vast majority of what they do is either buy the limited partnership interests of existing limited partners. So endowments, foundations, high net worth individuals.
- [12:56]
C
Those that are investing in the private equity fund.
- [12:59]
A
Exactly. And they may want to sell their fund interests to other funds, which provides.
- [13:04]
C
Liquidity for the investors. Because one of the downsides of private equity is the illiquidity. Okay, got that.
- [13:09]
A
That's exactly right, Jacob. So the ultimate buy and hold investment is private equity. And so this is a fresh pool of liquidity to help folks sell in the middle of that fund's life. So roughly half of there were $200 billion in private equity interests will transact this year. Roughly half of that $200 billion is what I've just described. So essentially the secondary or the aftermarket of fund partnership interests, the other half, and those are considered LP LED transactions because the LP itself is deciding to sell its interest in the fund.
- [13:44]
C
Is that an organized marketplace or no? Is that an efficient marketplace or no?
- [13:49]
A
Increasingly, yeah, we would like to think that it is. There are investment banking groups such as ours that essentially do nothing but sell large portfolios of secondary private equity and drive value in pricing. And there's certainly broad bands at which we expect things to partnership interests to trade at. So it's increasingly becoming efficient. But as you might imagine, all things private equity, it's not perfectly efficient in the way you would. It certainly might defy the efficient market hypothesis in ways that the public markets might not. Half of that a hundred billion dollars essentially is going to GP LED transactions such as continuation vehicles, where the GP says, you know what? I am proactively taking measures to find interim liquidity for my portfolio companies that are sort of non traditional. So a traditional exit, if a traditional exit is a sell to another sponsor or to a strategic or even an IPO to the extent that those traditional paths to liquidity are not available to a portfolio company, Often a secondary path to liquidity, a path to liquidity using secondary private equity investors is available, and that's typically through a continuation vehicle. That's the equity side. There could also be a pref or other debt oriented ways to bring interim liquidity to portfolio companies as well. The reason why we call it secondary private equity is the source of all of these alternatives are essentially the large secondary private equity funds that have been raised by the likes of Blackstone, Aries and others.
- [15:20]
C
Do we have any kind of numbers on how often a private equity firm buys a company and they can't exit it within their fund timeline?
- [15:27]
A
The vast majority of GP LED continuation vehicles are actually the other transaction format. It's when a company is a trophy asset essentially and it has performed its way.
- [15:37]
C
Oh, and they want to keep holding it.
- [15:39]
A
Exactly. And they want to keep holding. But more importantly, they need to raise fresh capital to deploy into the company because it's growing so fast. So the majority of GP loads is that transaction format, as opposed to the prior one I described, where it's essentially a cleanup trademark.
- [15:54]
C
How often does that happen where it's a home run and they want to hold onto it and keep investing in it?
- [15:59]
A
What we can say anecdotally is that it's increasingly becoming the case where new investors are investigating with GPS when they're raising new capital. Why haven't you pursued continuation vehicles? Why haven't you not pursued sort of well priced interim liquidity for your investors? So while it's certainly not common for every fund, it's becoming much, much more accepted. And frankly, LPs have gone from sort of being likely skeptical of the phenomenon to almost demanding it where there is an opportunity to find an optional fresh liquidity. And if a GP doesn't take it, they almost have more to answer for than if they do.
- [16:41]
C
What are the implications here given that that's one of the downsides of private equity? At least it was that they buy a company and there's still Runway left and now they have to sell it just because their fund is ending. So given that that's going to change here, what do you think of the implications of that?
- [16:58]
A
I think you're hitting on one of the broader implications, which is it should dial down the illiquidity concern for private equity generally. Right. I mean, as the secondary market for private equity matures and deepens, not only are fund interests themselves much more liquid than they've ever been, but exposure to portfolio companies themselves has also become more liquid. So I think more liquidity drives efficiency and should drive down whatever barriers would have kept folks from investing in private equity, whereas they might not have in the past.
- [17:30]
C
Jeff, what are the major reasons that a company might underperform under a private equity firm's watch and that might cause them to say they can't sell the company and they have to go about a continuation vehicle. What are the most common reasons for that?
- [17:46]
A
Well, again, Jacob, the most common rationale for a continuation vehicle is actually the opposite, right? It's when a company is performing so much that there is a high degree of desire to remove that company from it's a commingled fund isolated into a continuation vehicle, continue to feed its success with more time and more importantly, more capital in terms of the cleanup trade, where a fund might have a collection of assets that otherwise didn't sell and they're looking at the horizon of the fund vehicle itself. You can imagine anything from the market moving against a company to poor management. It could be the GP's fault itself by not feeding the company with appropriate growth capital. I mean, any number of reasons for why any other private investment might fail are reasons why a private investment might fail when it's wrapped inside a portfolio company. I mean, there's any. The universe of, in this case, you know, failure has a thousand fathers, right?
- [18:41]
C
How do you think continuation vehicles will change over the coming years? And how do you think this will continue to shape the private equity world?
- [18:50]
A
Jacob? I think that continuation vehicles are here to stay. Certainly when I first got into private equity over 20 plus years ago, there was a little bit of a valence of a gray market. Gps didn't love the secondary market in their own fund interests. But increasingly over time it's grown to upwards of a $200 million market. So definitely it has been accepted. And I think we are seeing the exact same thing with the newest secondary private equity toolkit, continuation vehicles. They are absolutely here to stay. We've already seen the beginnings of their impact to things like hold times. You know, portfolio companies are being held by private investors for much longer and I think we'll continue to see that. More interestingly, we're seeing new entrants into the continuation vehicle market by way of the large commingled 40 act permanent capital vehicles that are being floated by large private equity and secondary private equity sponsors. So again, I think yet another user for an important toolkit. And I think what we're seeing now, extended periods of hold, et cetera, are going to continue as continuation vehicles are here to stay.
- [19:56]
C
What do you think the takeaway point is here as we wrap up the show?
- [19:59]
A
Jeff, I think that essentially for your audience, when they are selling their company to a private equity fund, as we just discussed, it's very possible that they are in bed with that private equity fund for much longer than they might have previously expected, either because their company is succeeding beyond any of the initial projections of the private equity fund and so they want to hold it longer and get more capital, or that it's resided within the arms of a private equity fund for five, six, seven, eight years and it's possible that they don't sell it at a loss, they'd rather keep that portfolio company for another chapter. In which case, I think obviously, as private companies are held for longer periods of time by private funds, it makes liquidity events that much longer to come to fruition.
- [20:47]
C
Well, there you go, ladies and gentlemen, that is the continuation vehicle in a nutshell. That's Jeff Bollerman. He's the Managing Director in the Private Capital Advisor Group at Raymond James in New York, New York. We'll have his contact information in the show. Notes and Jeff, thanks again for joining us on M and A Talk.
- [21:06]
B
M and A Talk is brought to you by Morgan and Westfield, a nationwide leader in merchant mergers and acquisitions for small to mid market companies. If you've enjoyed this show, don't forget to subscribe and leave a review. Learn more@morganandwestfield.com While we take reasonable care to select recognized experts for our podcast, please note that each podcast presents the independent opinions of such experts only and not of Morgan and Westfield. We make no warranty, guarantee or representation as to the accuracy or sufficiency of the information provided. Any reliance on the podcast information is at your own risk. The podcast is for general information only and cannot be considered legal or professional advice.