P How to bring private equity to the P-A-R-T-Y

Leisure Wallet Report 2012 Zolfo Cooper
Industry insight
How to bring private
equity to the P-A-R-T-Y
Patrick Marrinan | Zolfo Cooper, Corporate Advisory Services
Zolfo Cooper has advised the boards of
Pho, Be At One and Blanc Brasseries on recent
fundraisings. In this article Patrick Marrinan,
an experienced corporate finance professional
at Zolfo Cooper, outlines some of the key
considerations for entrepreneurs who are
contemplating going to market to seek funding
from professional investors.
Five steps to the private equity P-A-R-T-Y
What often separates the great deals from the less successful ones is
planning and preparation. Having a concept that has the potential to
attract the interest and wallets of private equity (PE) is a
tremendously exciting prospect, but the capital raising process
represents a momentous journey, and entrepreneurs are faced with a
significant number of difficult decisions along the way.
The aim of this article is to demystify the PE capital raising process,
and to outline the key issues that should be at the forefront of an
entrepreneur’s thinking when embarking on a process. In my view, the
primary considerations for most capital raisings can be encapsulated
in five points, which are discussed over the following pages.
“It is common for young or
fast-growing companies to
discover a disconnect
between the quality of their
financial information and the
quality of the data that is
required by an investor during
due diligence.”
Preparing your business for market
There are some fundamental questions that all
owner-managers need to ask themselves when they
first consider bringing in new investors. The opening
and most critical question concerns the quality of
the business, because without a strong consumer
proposition and financial model you are unlikely to
be a viable PE investment option. Ask yourself — is the business
sufficiently differentiated, niche or special, when compared to the
competition and in the context of the market in which it operates,
and have you perfected the financial model to deliver an attractive
return on investment?
From a financial perspective, investors are drawn to businesses that
can demonstrate a track record of generating profits, the potential to
improve profitability going forward, and high levels of return on
capital employed.
If the consumer proposition and financial characteristics are sound,
the next consideration is management — is the business run by quality
operators and, importantly for PE, how strong is the accounting
function? In most cases, the pedigree of the operations team is known
to the investor community and is evident by the success of the
business to date. What is often not so obvious to the outside world is
the degree of in-house professionalism that exists in the finance
department. In our experience, a full time, permanent Finance
Director (FD) is crucial to a successful capital raising and serves to
provide investors with confidence in the historic financials.
Ultimately, the worst thing that can happen is for a potential investor
to question the numbers in the business plan because of a ‘nasty
surprise’ that emerges in the course of due diligence.
It is common for young or fast-growing companies to discover a
disconnect between the quality of their financial information and the
quality of the data that is required by an investor during due
diligence. Once they are satisfied about the concept, financial
investors scrutinise the accounts at a detailed level to help them get
comfort that they really know what they are investing in. The process
can be intense and I am never surprised when management teams
speak of the stress heralded by the PE due diligence process. This is
where a seasoned FD can add significant value to the process, both in
the preparation and presentation of the financial information.
Continued overleaf
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Zolfo Cooper Leisure Wallet Report 2012
Industry insight
How to bring private equity to the P-A-R-T-Y
...Continued from page 25
Aggressive but supportable business plan
When working with entrepreneurs, we often talk
about the need to present an aggressive but
supportable business plan. The business plan has to
show a sensible balance between offering attractive
returns to investors at exit and a realistic rate of
growth. As a general rule, PE firms like deals that
return at least 2.5 times their original investment. If the business plan
shows that this level of return is only achievable by opening ten sites
per year in central London, the plan will most likely be viewed as
overly aggressive. Where the appropriate returns can be achieved by
opening, say, three sites per year, the plan becomes entirely
The team is all about having the right people, in the right roles, to
deliver the plan. Investors will review the current head office cost
with interest and interrogate the business plan for the timing and cost
of future hires. We are frequently asked how investors treat a
business that has invested in head office infrastructure ahead of a
planned roll out. Overall, most investors prefer that the owners have
invested in experienced management, and any downside from the
higher costs is generally offset by the higher level of comfort the
investor has in the delivery of the plan. The key is to get the right
Management remuneration will be based on a reasonable market
salary, with the potential for some modest annual bonus for exceeding
the business plan. This can be a significant change for an
entrepreneur used to taking dividends as well as a salary to fund a
lifestyle. Going forward, your new partner will understandably want
to see every spare penny reinvested into the expansion plan. The
focus is on creating the value at exit, and growing EBITDA is the
primary objective.
Realise your go-to-market strategy
Selling a business (or part of it, at least) is not like
selling a house, and due consideration needs to be
given to the go-to-market strategy. One of the key
questions is: do you set your target deal structure
prior to launching the process and request offers
based on that structure; or do you let the
prospective investors propose a deal structure and select the one that
is most attractive?
02 Tourism, Hospitality & Leisure
Whatever the chosen strategy, it is imperative that you have an open
dialogue with your advisor about your objectives from the
transaction. Your advisor can explain the pros and cons of the
different potential structures and financial instruments, as well as the
impact and consequences of the various structural options, in terms
of both risk and return.
Traditionally, PE money comes in via a new company specifically set
up for the transaction. The majority of the capital is usually invested
in the form of loan notes, which attract an interest rate (coupon) that
rolls up until exit or some future date. This approach helps de-risk the
investment for the investor, as loan notes are paid out prior to any
equity distributions.
Similarly, for entrepreneurs who have invested many years of toil in
building the business, loan notes help to lock in most of the value
that has been created to date. For example, if you have a business
worth, say, £10 million that receives a new cash investment of, say,
£5 million, then a standard deal structure, assuming no senior debt,
would have around £14.5 million of loan notes and £500,000 of
ordinary shares. In this structure most of the current value is locked
up in the loan notes and the equity takes the upside above the value
of loan notes. However, the key issue in any structure with significant
amounts of loan notes is the interest rate rolling up on those loan
notes. Loan notes typically attract annual compound interest of
between 5% to 12%, and can materially increase in value through the
course of the investment period. In the earlier example, if the loan
notes have a 10% coupon rate and the investment ran for five years,
the value of the loan notes and rolled up interest on exit would be
£23.4 million. In this situation, management would have to increase
the value of the company by almost 60% before their equity had any
Of course, some entrepreneurs are more focused on the potential
equity upside and are willing to forgo some or all of their founder
loan notes in favour of retaining more equity. This structure reduces
the amount of loan notes that rank ahead of the equity pot but is a
riskier option for the entrepreneur. In return for adopting this ‘equity’
investment approach, an entrepreneur should be able to demand a
bigger slice of the equity pie, particularly if the investor has loan
notes in the structure. This approach also sends out a clear message
to the prospective investor that management are highly confident
that they can deliver the business plan.
Leisure Wallet Report 2012 Zolfo Cooper
Industry insight
Tax and legals: seeking specialist advice
You could write a book on the subject of tax when it
comes to M&A, especially in relation to ownermanager deals. There are multiple technical issues
which require expert input to successfully navigate,
however, in my experience there are a few
straightforward pointers that entrepreneurs should
take on board early in the process.
Fundamentally, entrepreneurs should engage a credible, experienced
and proactive tax advisor early in the process to help navigate the tax
minefield. A single capital raising process can touch on tax issues
relating to income tax, capital gains tax, entrepreneurs relief, EIS
investments, VAT, corporation tax and stamp duty to name just a few.
The rules, and some of the treatments of certain issues, are not
intuitive, so specialist help is required.
The ultimate objective of the process is to deliver an amount of
money, whether today or at exit, into the entrepreneur’s bank
account, and tax will play a huge part in determining that final figure.
With this in mind, a specialist can deliver extraordinary value, and it
is money well spent.
From a legal perspective, the biggest issue that entrepreneurs face is
loss of control. Recognising the difference between economic
ownership and control is important and entrepreneurs need to go into
legal negotiations with their eyes open. In exchange for investing a
significant amount of capital into the business, investors will typically
require several key elements of control.
These include:
Drag rights: the investor’s ability to ‘drag’ other shareholders into a
transaction to sell the business at some point in the future. In the
unlikely scenario that the founder does not want to sell the business,
the contract dictates that the founder can be compelled to sell his/
her stake alongside the PE house.
Leaver provisions: clauses that set out what happens to the shares of
key managers who leave the business for a variety of different
reasons. These are often classified as good leavers (retirement or
illness) and bad leavers (eg gross misconduct). These provisions
impact how the value of the founder manager’s shares are treated at
the time of leaving the business and require careful negotiation to
protect the founder manager’s rights.
Investor consents: an investor will expect to have consent rights on
the big decisions such as site selection, significant spending, any key
personnel appointments (above a certain pay grade) and approval of
the annual budget.
You need to ensure you use a lawyer who is experienced in private
equity transactions. A commercial lawyer can expedite the process by
striking a good balance between protecting the entrepreneur’s
interests within the legal documents and adopting a pragmatic
approach to negotiations by avoiding indulgence in extreme
It is important for entrepreneurs to remember that while the contract
is important, the investor is reliant on the management team to
deliver future value and is keen to maintain a strong relationship. This
generally means that these types of protections are rarely
contentious. Continued overleaf 
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Industry insight
How to bring private equity to the P-A-R-T-Y
...Continued from page 27
Your choice of partner
Put simply, this is the most important consideration
when raising PE capital. The type of investor you
select should be driven by the needs of the
management team and the business. Entrepreneurs
should ask themselves whether they are looking for an active investor
that has been there, done it, and can add material value. On the
other hand, you may feel that too many cooks spoil the broth and just
want the cash.
If you are in the market for a PE partner with genuine sector
expertise, it may well prove to be more expensive compared to other
investors. After all, sector-focused investors have worked to develop
niche experience, and this may come at a price. The quid pro quo for
this is that a sector specialist should help the management team
deliver, or even exceed, the business plan forecasts. For many
entrepreneurs, the experience, knowledge and contacts that a
specialist can bring to the board room is a big draw.
If you fall into the other camp and just need the funding, it may be
that Enterprise Investment Schemes (EIS) or Venture Capital Trusts
(VCT) are more cost-effective solutions. These vehicles appeal to
retail investors because of favourable tax incentives, and individual
companies can raise up to £5 million per year through an EIS or VCT.
The required return of EIS and VCT investors is generally lower than
the standard PE hurdle, which means that they may be able to pay a
little more for a business on the way in. On the other hand, the
business is unlikely to get the same added value from an EIS or VCT
fund, versus an investor that specialises in a particular sector.
A successful capital raising process may result in multiple proposals
from the investor pool and the advisor will negotiate with the serious
parties to deliver the optimum financial terms. Quite often, at the
end of the negotiation process, the difference between the best
offers can be negligible.
At this point, the strength of relationship between entrepreneur and
investor becomes the deciding factor. Entrepreneurs often talk to me
about issues such as trust, support and respect when considering the
best partner. Inevitably there will be some difficult and challenging
conversations with your new investor partner during the investment
period and the strength of the entrepreneur-investor relationship is
key to fostering an environment that allows the management team to
deliver value for all shareholders.
04 Tourism, Hospitality & Leisure
Bringing private equity to the P-A-R-T-Y
Bringing external professional investors into a fast-growing company
often takes owner-managers way beyond their comfort zones, and is
plainly not for everyone, or every business. But, for the right
concepts, it can deliver game-changing growth. Following the steps
set out in this article will help you deliver the right deal for you and
your business.
Patrick Marrinan is a senior associate in the Corporate Advisory Services team at
Zolfo Cooper, specialising in tourism, hospitality and leisure
“The entrepreneur-investor
relationship is key to
fostering an environment that
allows the management team
to deliver value for all
Industry insight
Leisure Wallet Report 2012 Zolfo Cooper
Tourism, Hospitality & Leisure 05
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This publication does not constitute professional advice. Whilst every care has been taken
in its preparation please note that it is intended as general guidance only. Before acting
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