Anyone following the M&A market will have noticed the success rate of private equity players in M&A auctions. This is not necessarily because a private equity house is prepared to pay more — there are a number of reasons why the auction process tends to favour a private equity bidder over a trade buyer.
Focus of due diligence
For an industry buyer, making a major acquisition will require a great deal of careful thought about the way in which the target can be integrated with its existing business. There will be ramifications operationally; the impact on existing customer and supplier arrangements for the new and legacy businesses, the need to integrate and harmonise employment policies, pensions and benefit provisions. This places a burden on the diligence process, which has obvious timing implications and adds to the complexity of that process.
By comparison, while private equity houses do adopt ‘buy and build’ strategies (bolting together two or more existing businesses), far more often, buy-out houses acquire on a standalone basis and have no need to plan for the integration of the business. The focus of due diligence will be on the target’s results and anything with a financial impact. Its due diligence, being narrower and more focused in scope, can be accomplished more quickly and assimilated more easily. Starting at the same time as an industry buyer a private equity house has an inbuilt timing, and process, advantage.
Familiarity with the auction process
Auction processes are tightly-driven and controlled, usually by the seller’s corporate finance adviser. There will be various rounds and processes, during which the seller’s advisers will try to ensure that everybody follows the rules so that they are in a position to assess competing bids on the same basis against one another.
For private equity houses this is a well-trodden path. This familiarity with all permutations of the process and with key advisers — whether accountants, lawyers or other providers of due diligence — enables the team to react quickly. This is particularly the case towards the end of the auction process, where sellers and their advisers will expect bidders to be in a position to enter into the final signed documents only days or hours after the final round has closed. For an industry bidder embarking upon a transformational acquisition, this timetable can be absurdly compressed.
Keeping up with market practice
One of the clearest trends in the acquisition process in the past couple of years has been a steady erosion of the rights of recourse which buyers traditionally negotiated with sellers: caveat emptor back with a vengeance. This is apparent across a number of areas of a typical sale agreement — it is now common to find: no tax indemnity; limited warranties, capped at a very low percentage of the purchase price; and no post-completion testing of a net asset level.
Private equity buyers are not only used to seeing these terms but — importantly — also have experience of seeing how the deals pan out to give them a degree of comfort with accepting such limited recourse. Industry buyers may well have difficulty accepting this, especially when they have sold businesses in the past with more onerous seller’s terms.
Availability of funding
Private equity houses have significant cash resources, the benefit of a buoyant debt market, a great deal of expertise in raising debt finance and familiar techniques that they use to reassure sellers that they can deliver on closing. In contrast, a corporate buyer that needs to raise money for the acquisition may face timing difficulties.
Merger clearance filings
Private equity houses, while usually priding themselves on their sector specialisation, very rarely buy businesses that compete directly with another business within their portfolio. Therefore, although they are frequently in the position of having to make merger clearance applications prior to closing deals, these rarely raise substantive competition concerns and so are much more certain in terms of deliverability (which is obviously a key attraction to any seller).
In contrast, most trade buyers are likely to have some competition issues that need to be analysed prior to signing the contract, and which may give rise to more substantial regulatory investigation. Also, most private equity houses are now adept at keeping up-to-date turnover information for their portfolio companies, and so are usually several steps ahead in the process of being able to prepare filings to a tight timetable (provided, of course, that the sellers have done the same with the target).
Some tips for the industry buyer
Despite the points set out above, an industry buyer can compete with a private equity firm to win an auction. To do this, the industry buyer needs to:
be prepared to be nimble;
strip out layers of its own internal bureaucracy which impede speed of response and decision-making;
be prepared to concentrate on the key areas of value and risk and observe the law of diminishing returns when planning and conducting its due diligence;
be conscious of the current state of the market (which moves by the month) in the sale terms that sellers can expect in contested auctions; and
be prepared to offer equity-style incentivisation for the incoming management team.
None of the above can entirely overturn the inherent advantages that private equity houses, as professional corporate acquirers, enjoy. Yet such relatively simple strategic forethought can go a long way towards levelling the playing field. After all, if you are going to beat the professionals at their own game, it pays to understand the rules.
The author is a partner at Weil Gotshal & Manges.
