User group summary: August 2024
Background
In previous user groups and training sessions our focus has been on the wealth accumulated by General Partners at private equity and venture capital firms. However, this session we investigated what the implications are for business owners when being bought out by Private equity or receiving an investment from a VC fund.
We started the session by clarifying that:
Private equity typically buys entire companies (typically more mature organisations) – with the majority being the purchase of private / family businesses. The purchase price is paid to shareholders (albeit subject to conditions outlined below)
Venture capital invest money in smaller, high growth firms in return for some equity (i.e. ownership). New shares are created by the business (not sold by existing owners) thus diluting existing shareholders ownership %. The money raised goes into the business to support growth, marketing, R&D etc and does not go to shareholders.
Private equity acquisition types and tax implications
When a private equity firm buys a company, the structure in which the acquisition takes place can have a significant impact upon the tax paid by the owner.
Asset purchase – the target company remains in force, but some / all of the assets are sold. This is less favourable from a business owners tax position.
Equity purchase – the ownership of the company is purchased; the company Is closed, and the PE firm will establish a new company (often within a holding company structure). This is the most tax effective sale type for business owners.
How much do owners get when private equity buys a company.
Quite simply they will a package that is equivalent to the value of the business at the time of the acquisition. However, they will often not get a huge cheque for the full value of the business on the day the sale goes through. Many private equity firms recognise the importance of retaining key staff / owners and structure the sale package accordingly. For example, owners might get 50% of the acquisition value up front followed by:
Rollover requirements – a requirement that they invest some of the acquisition proceeds (i.e. up to 50%) in the new business to ensure they have bought in to the success of the new business.
And / or Earn outs – the remaining consideration is only paid if certain financial targets (revenue, EBITDA, profit etc) are met. If they are not, met no further payment I made or the calculated on a sliding scale.
What happens to directors when PE completes the acquisition?
Quite simply PE will retain those they see can add value, remove those that do not fit the needs of the PE fir and then appoint new directors – often associated with the PE firm themselves. New / retained directors er incentivised to meet stretching financial performance targets.
What are the different funding rounds that have VC involvement?
The businesses that a VC fund invests in are typically smaller and higher growth, thus riskier.
There are normally four funding rounds undertaken by growing businesses:
Seed financing – often provided through personal savings, family, and angel investors. Normally up to about 2m, often giving away 10-20% equity.
Series A – raising 2-15m with a further 20-30% equity dilution for owners.
Series B – raising between 5 and 50m with an additional 10-25% dilution for owners.
Series C – raising 20m+ with a further 10-20% equity dilution for owners.
The above figures are typical ranges but can differ depending on the nature of the business / their growth prospects.Note that funds raised go to the company, not to shareholders!
What happens to directors when there is VC investment?
They are often retained, but the board is often expanded to include additional people appointed by the VC fund, who should provide additional expertise / experience to the company.
Directors are normally incentivised to grow the firm through the allocation of additional equity / share options. This is cheaper in the short term for the business, many of which are loss making so paying out cash bonuses are not financially palatable.
What are the signs for VC / PE interest in a company?
Focus in hot sectors such as biotech, AI, Defence
Monitor the rapid appointment / removal of directors.
Enhanced disclosure above regulatory requirements
Many PF / VC firms focus on certain sectors / types of company.
Owners have sold previous companies and have a good track record of growing and selling businesses.
Cash / preference shares / increased equity in the financial accounts.
Successful company closures
Scanning the financial / business press
Using Code – valuations and past income
When applying the above Code-FI can support this analysis by
Valuing current and previously sold businesses where the sale value was unknown.
Enables a fuller picture to be gained as estimate income and dividends can also be established.
Finally - please remember that there is NO User Group session in August! We hope you have a lovely summer and we will catch up in September unless we hear from you otherwise.
Thanks,
Jon
