In this episode, Geoff Cockrell, the chair of McGuireWoods Private Equity Group, talks about private equity presence in M&As from his wide scope of experience in mergers and acquisitions and financing transactions. Join host Domenic Rinaldi and Geoff as they discuss clarifying private equity and its true meaning and trends within the private equity industry as it relates to mergers and acquisitions. In addition, they discuss what issues private equity firms love to see and certain terms within an M&A deal to watch out for.
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Geoff Cockrell: Private Equity
We are in for a real treat. We are being joined by Geoff Cockrell. He’s the Head of the private equity practice for McGuireWoods, a premier law firm with a stellar 185-year track record and operations in 26 countries. Geoff has built an incredible practice representing private equity sponsors, strategic purchasers, and sellers across a broad range of industries. He has clearly become a go-to resource for private equity mergers and acquisitions. I look forward to unpacking his knowledge. I’m especially excited because many of our smaller and lower middle-market clients are somewhat mystified about private equity and whether or not their companies would be of interest to private equity groups. Geoff, thank you so much for joining me. I’m happy to have you here.
I’m happy to be here.
Geoff, why don’t we start with if you could talking to the M&A Unplugged community about your practice. What you do a little bit about McGuireWoods and we’ll dive into private equity and the types of transactions that they do and what they look for.
I’m the Head of the private equity group here at McGuireWoods. We have about 1,100 lawyers spread out across the country representing all sorts of clients and things. I principally represent private equity funds and acquisitions of portfolio companies and those middle-market, lower-middle market platforms, which might range from an enterprise value of $10 million to $300 million. Once a platform is acquired, many of them, their growth strategy are through acquisitions. They’ll be doing all sorts of acquisitions that could be anywhere from $1 million or $2 million up to $50 million acquisitions or more. I spend a lot of time doing mergers and acquisitions for private equity funds.
How did you wind up focusing on this area? When I read through your background, that’s not where you started. You worked your way over to private equity and now you’ve been doing this for a while.
Historically, I’ve always been a knuckle-dragging M&A lawyer that can be in a lot of different contexts. Private equity work is M&A work on a little bit of adrenaline and like many things in the law, your career follows where the work is and where you’ve had some success in building that. That oriented towards private equity. Within that, McGuireWoods has a big and strong healthcare group. I’ve gravitated towards doing more healthcare transactions, but all of it is M&A related and wherever I can cobble together some sector expertise that usually helps them build in practice.
I’m excited about getting into your work and unpacking some key nuggets for the audience. Let’s start with demystifying private equity. Many people have improper perceptions of private equity. Maybe could you break down private equity for the audience and what does that mean?
Private equity is a pool of capital that is going to buy and grow businesses. Whether that is capital that’s pooled from pension funds or wealthy families, private equity funds will pull together this pool of capital and buy and build companies. Private equity sometimes gets a bad rap on television or in the media that they’re businesses buying things and chopping them up. That’s not been the experience of what I’ve seen. They generally will come in and buy a company and build it as quickly as they can, but growth-oriented by and large.Private equity is just pools of capital that are going to buy and grow businesses. Click To Tweet
There are flavors of the private equity group and they get morphed together. They shouldn’t be lumped together. I’m specifically talking about the difference maybe between private equity groups, family offices, fundless sponsors, and independent sponsors who have exploded over the last few years. Could you talk a little bit about the differences between those groups of buyers?
A private equity fund is a pool of capital that generally has a ten-year lifespan. Pension funds and other institutional investors will commit capital to this private equity fund for the purpose of buying and building companies. They tend to have a limited lifespan. A private equity fund is usually buying a company with the idea of building it over the next 3 to 5 years and selling it and maybe to a strategic buyer, maybe to a larger private equity fund. Their general idea is to keep it for a limited period of time because they’re ultimately returning capital to their investors over the ten-year life of the fund. A family office is like you might expect, it’s a wealthy family or a group of wealthy families that they made their money doing whatever. Now they have this enormous pool of capital and they might be investors in private equity funds. They also might be direct investors where they could acquire companies directly.
There are some key differences with family offices, one of them being that they are less likely to need a limited duration investment. The family office might have the intention of buying companies and holding them indefinitely. Whereas a private equity fund is going to be built to sell that company in 3 to 5 years so there are some key distinctions. Independent sponsors or fundless sponsors, you might think about it as more like private equity. A private equity fund has its pool of capital, and if they’re going to buy a company, they’ll be putting in some of their dollars as equity and borrowing money from a bank or other lender to fund the acquisition. An independent sponsor is doing the same thing, but they don’t have the pool capital.
If an independent sponsor is looking to acquire a company, they’d go buy it in the same way that the private equity fund would and they would enter into a letter of intent with the target. The independent sponsor has to turn around and source not just the debt to fund the acquisition but also source the equity. There was a time when independent sponsors and fundless sponsors were a little bit more in the backwaters of the M&A community. They’ve come to their own and become incredible and more established. Capital providers are much more ready to work with them. An independent sponsor is also a viable acquisition source.
Geoff, when you talk about independent sponsors like private equity groups, not all are created equal. Are there things that sellers should be looking for an independent sponsor that separates them from the rest of the pack?
Sellers often think of independent sponsors specifically in evaluating their execution risk of how likely are they going to be able to get to the closing with all of the capital to complete the transaction. Since they don’t have the equity portion of the purchase price already built into a fund, they have to go secure it. There are two things I should be looking at if I were a seller and by no means should independent sponsors be disqualified as viable buyers. One is where are they going to get the capital from and how close are they to that capital? Meaning, have they already had conversations, have they done transactions with capital providers in the past? It’s evaluating how secure the capital is that is going to be able to show up at the closing. Secondly, looking at their track record of having gotten to closing. What you probably don’t want to do is enter into a letter of intent with an independent sponsor that’s going to have difficulty putting together the capital to close the deal.
Switching back over to the private equity world, are you seeing any trends that have appeared or emerged that have surprised you or trends that you didn’t think are going to stick but are sticking?
I do a lot of healthcare deals and the pricing on healthcare platforms has been white-hot, almost difficult to imagine multiples 12, 13, 14 times trailing EBITDA are not completely uncommon. That’s a lot to pay for an acquisition and puts lots of pressure on quickly growing it. The pricing has been a little bit surprising how long it has stayed this high. Partly that’s an immense availability of capital. There are a lot of equity dollars available in private equity and in the hands of a strategist. The interest rates continue to below. The debt financing is available and there’s an immense amount of capital chasing an unlimited number of deals. How long does that continue? It’s hard to know but that’s probably been the most surprising thing.
Are you seeing those sorts of multiples on add-ons as well as platforms or those multiples apply to platforms and add-on multiples are probably at a different level?
They would be at a different level. A platform has altogether different pricing around it. Part of why private equity funds enter this arena in the first place is smaller things cost less as a multiple of EBITDA and larger things cost more. If you can buy one or many smaller things, put them together and integrate them, you’ll creep up into higher multiples of EBITDA by building scale. It’s one of the ways that they make money. Certainly not the only way, but multiple arbitrages are part of the model.
Let’s move away from price for a little bit and let’s talk about what private equity groups covered in a target. What are the things that a private equity group analyzes in a business? What are the things that pop out that private groups love to see like the soft and operational issues and that stuff?
It probably depends. If you’re talking about a target that is a platform they’re going to build around versus an add-on the acquisition. In an add-on acquisition, they probably have fewer needs from that target. Meaning the target may have an incomplete infrastructure. It may have more challenging contracts. If they would acquire that add-on acquisition, they’d be pulling it onto their platform, which has its own infrastructure and own contracts already in place. They can deal with a less built out entity, which is partially why smaller companies trade at lower multiples as they don’t usually have all of that infrastructure. Whereas a larger platform or larger target that is intended to be the platform itself, it usually needs to be more built out in the sense of infrastructure and personnel or the private equity fund may be bringing the personnel, but it needs to be a more established business.
In that context, they’re usually looking for either a company in an area where there are a lot of things to buy. Meaning if I’m a private equity fund and I can buy a platform and I can see a pathway to buying a bunch of other things, that’s one way to make it grow. If there’s an impediment to the growth that is something they can solve. Take an aging family owner that has limitations and what their skillset is as far as taking the company to the next level and bringing in more professional management. That might be an impediment they could solve or there may be a growth strategy that the company doesn’t have the capital to execute on. The private equity fund obviously has a lot of capital. They can help solve those impediments. It’s identifying, targets where there are problems that they know they can solve.
Geoff, many of the followers in the M&A Unplugged community are owners of businesses. Most would be considered add-ons but there are a bunch out there that are platforms as well. If you could talk directly to those owners, advise them on things that they should do or know about if they’re going to engage with private equity groups. What advice would you offer to those owners?
The first advice and the earliest advice would be to assess your tax structural situation. It’s not at all uncommon by the time I’m arriving on the scene, maybe there’s a letter of intent already executed or you’re in the midst of arriving at a transaction with a buyer where we’ll encounter problems with the target. It may be a C-corp where you’re trying to solve for two levels of tax at the corporate at the individual level or you may be trying to solve for a problem where you’ve got three owners and two other people that probably should have been owners but aren’t. You want to get them some of the proceeds in the transaction but you’re going to have a tax challenge in getting there.
For a lot of tax problems, there are solutions to them, but those solutions need some distance from when the transaction is occurring. You may have some ability to fix things that are there but your ability to fix them is going to quickly go away as you get closer and closer to the transaction. The first advice I would get is figuring out if you have a tax problem and figure that out right away and if there’s any way for you to solve that problem before you get too close to the transaction event. That’d be my first advice.A seller looks at two things - where the buyer is going to get the capital from and how close they are to that capital. Click To Tweet
To the M&A Unplugged community, my suggestion is you figure that out before you ever go to market. Work with your accountants or hire a specialist that can help you look at the potential deal structures and what your net walk away will be. That will inform you as to whether or not now is the right time. I will also caution you that you need to make sure that you’re working with advisors that understand M&A transactions. As Geoff is alluding to, there are lots of creative solutions to fixing a tax issue. That’s where people who do this day in, day out matter. Geoff, are there other items that you would recommend to owners who are going to engage with private equity groups?
You might think about figuring out if your financial reporting is up to snuff because any buyer is going to need to understand the economics of your business. Many sellers are operating on a looser framework. Many of them are cash basis taxpayers, which is not problematic in and of itself but can create some friction in getting from the starting point to the ending point. Figure out if there are some improvements that can be made in your financial reporting so your financial statements are a little tighter because the looseness in them is going to create challenges down the road in the transaction.
I had Tad Render on a couple of episodes ago. He’s the head of the transaction services group over at Miller Cooper and he talked about how often the balance sheet becomes such an issue in these transactions. People would not properly be accounting for things. The inventory oftentimes a big issue and not understanding the concepts around networking capital and what’s going to be transferred with the business. I’m assuming that that’s a lot of the stuff that you’re talking about?
For sure. The valuation and understanding of valuation from a buyer is if I’m going to pay, let’s say $10 million for your company. What the buyer means in that is I’m going to pay $10 million for your company and it’s going to have no debt on it. If there’s any debt that gets paid out of the proceeds, there’s going to be no cash in it, which means you can take the cash, which that’s a plus. Here’s where it gets sometimes difficult. The $10 million assumes that you are going to deliver to me as a normal level of working capital and I’m going to get that normal level of working capital. Figuring out what that normal level is can be slippery if you don’t have a historical accrual balance sheet.
Plus, there are many sellers who have in their own mind the idea, “If I close on December 31, all the accounts receivable that are there belong to me because those are pre-closing.” That’s not a crazy thought, but that’s not usually how evaluations work though. The buyer is expecting the delivery of a normal level of working capital, which is going to be a normal level of accounts receivable, inventory, and accounts payable. Figuring that out is you can do a lot of brain damage to navigate to that answer.
Let’s talk about how private equity groups approach the financing of transactions. I know there’s not one size fits all. Every deal is different, but you could talk at a high level about how private equity groups put together the debt and the equity and what that looks like in a typical deal. That’d be helpful.
There are different schools of thought on how much leverage is appropriate. At a certain level, a seller may have less interest in that topic. If I’m selling it for all cash, how the buyer wants to finance the company going forward is their business. If on the other hand, the seller is rolling over a significant portion of their proceeds into the go-forward company, the amount of debt impacts the seller both, in terms of the risk profile of the company going forward. Meaning, more debt has the potential for more risks but more debt also has the potential for a higher return. If I have a $10 million company and I’m rolling over $1 million, 10% of my proceeds, I may be rolling into more than 10% of the buyer.
The private equity fund may be putting in $3 million of its own money and you’re rolling in $1 million, which leaves $6 million that they’re financing from a bank. You’re $1 million, which is 10% of your proceeds is now rolling into a 25% interest in the buyer. That has both risks and an enhanced upside because of that same math. If they only borrowed $3 million, they’ve got $6 million of equity in your $1 million rollovers. You’re going to own it a much smaller percentage of the company on account of that. Debt has pluses and minus all the way around.
That’s a trend that we’ve seen in the deals that we’ve done. We’ve seen pick up steam over the last years. We’ve seen more private equity groups coming in and talking about rollover equity. Even in add-ons, we’ve seen that and that’s great. It can be a potentially great outcome for owners who don’t want to walk away from the business and continue to have some skin in the game.
On a platform, the typical expectation of a buyer is, the seller is going to roll over into a 20% to 30% interest in the buyer. That doesn’t mean they’re going to for the same reasons for the impact of debt. That doesn’t mean that the seller is rolling over 20% to 30% of its proceeds but it’s going to be rolling over some of its proceeds that are going to represent 20% to 30% of the buyer. That would be a fairly typical expectation in a platform acquisition. An add-on acquisition can be a little bit more mixed. Smaller add-ons tend to be more all cash. Larger add-ons tend to have more rollover potential. Some private equity funds want sellers to do more rollovers. Some private equity funds want sellers to do less rollover. As you’re talking to potential private equity buyers, that should be a topic to make sure your ideas and interests are aligned.
Aside from price and how a deal gets financed, are there some deal terms that you see people getting tripped up by oftentimes? What would your advice be around those deal terms?
The importance is the amount you’re going to walk away with in the sale. I’d go a step further. It’s not the price you get, it’s the price you keep, which sends you down the pathway of an indemnification exposure. When you sell a company, the price has some built-in assumptions. One of those assumptions is things are not all messed up in the company. The way that gets teased out is number one, the buyer is going to be doing diligence, looking at things and kicking the tires as you might expect. That’s not all it means. It also means the buyer is going to present you with a contract that makes you represent a bunch of things about the company, which are basically at varying levels having you tell the buyer that things are not all messed up. That is going to connect to indemnification obligations. What I would say is that those tend to not be wide open exposures. Meaning, it wouldn’t be crazy to think about indemnification as well.
Whatever happened on my watch is my responsibility and whatever’s going to happen on your watch is your responsibility. That’s not generally how it works out. The market has arrived at some answers on how much the seller is going to take. That usually surrounds ideas of my representations that are only going to last long. An escrow that I might have to put to support those indemnification obligations is only going to be so big. My maximum exposure to any of these ideas is only going to be so big. Part of the exercise for a seller is to know what the market ranges on those topics are. Number one, don’t let yourself be pushed into a corner that your indemnification exposure is greater than those market tolerances. Number two, not be asking for limits on that exposure that is outside of those market tolerances. A market deal is ultimately what you’re going to get and knowing what that means and arriving at it as quickly as possible is the best approach.
To the M&A Unplugged community, it’s important to reach out to people like Geoff, who’s an expert here and understands what the market is for these sorts of indemnifications and what’s appropriate. You could get hurt post-sale if you’re not careful about what terms and conditions that are placed into the contract, ultimately. I’m going to move back over to private equity groups. I’m sure you’ve been doing this for so long that there’s little that surprises you. I’m curious, when you’re working with private equity groups, these are sophisticated buyers. They do lots of deals and look at lots of deals, but are there a few areas where even after all of their experience, you have to talk them or walk them off the ledge, get over their skis or they get over-exuberant about a deal? What are the things that pop up where you have to bring your private equity clients back to earth?
It’s often a difficult seller and seller’s counsel. It’s like what we’re talking about on the indemnity, there are bandwidths of what things should be in as far as the duration of survival of your representation. It’s dealing with folks on the sell-side that maybe don’t know what they’re doing. They’re asking for things that are far out of the market that’s a challenge to bring it back into a normal bandwidth. The private equity folks can get fed up with that process pretty quickly. Oftentimes, I’m working with opposing counsel to try to draw them back into a more normal zone. It can be a real challenge.
It tests your legal skills. It goes beyond that. You become a part therapist and psychologist working through all of that.The looseness in your financial reporting is going to create challenges. Click To Tweet
The sellers are not wanting an exposure on a non-compete, which for a buyer of a business, it’s hard for them to tolerate them that requests. They have a short non-compete because, from a buyer’s perspective, I can’t buy your company and have you go out and take it back from me. Its expectations around some of those topics can get way out of whack.
Geoff, the information you shared has been incredible. Are there a couple of parting thoughts or comments that you would like to leave with the M&A Unplugged community?
I’d say start your thinking on a sale transaction earliest that you can fix things that need to get fixed before it’s too late to fix them. Talk to advisors, accounting, legal and otherwise that know what they’re doing and live in that space. You can make mistakes in both directions of either asking for things that are crazily inappropriate and you’re never going to get and can bog your transaction to a complete standstill. You can be accepting exposures that you shouldn’t be asked to accept and you’re accepting them because the advice you’re getting doesn’t let you know any better. My advice is to start the process early and talk to people who know what they’re doing.
My last question, Geoff, is there a book, whether it’s business or personal, that you’ve read that resonated with you and oftentimes recommend to folks?
The book I always recommend is less legal and more business development-oriented. I love the book Good to Great, which teases out some of the key characteristics of companies that grow. I’ve taken a lot of parts of that book and tried to implement the building of my own practice. Whenever I’m recommending a book, that’s usually the one I go to.
I’ve got to tell you that that book comes up at least 50% of the time when I ask people this question. It’s unbelievable how often that book comes up. It’s crazy but it’s a great book. There’s no denying it. Geoff, if people wanted to reach out to you and get in touch, how can they reach you?
My phone number is (312) 849-8272 or you can shoot me a note at [email protected].
Geoff, it was such a pleasure to have you. Thank you so much for joining us.
To the M&A Unplugged community, let me summarize a couple of things that Geoff brought up that were such great takeaways. One, there is a difference between private equity groups, fundless or independent sponsors and family offices. Understanding the differences between those is important when you think about who is your ideal buyer based on the outcome that you want to see. It’s also important to understand whether or not if you’re going to be a private equity target, are you a platform or are you an add-on? Equally important to understand all of that and know that the multiples that are going to get paid for a platform are completely different than for an add-on.
I know a lot of people get confused. They hear incredible multiples and they say, “My neighbor or my friend got this multiple for their business but there’s much to know and that goes behind that.” It’s important that you understand that because if you’re an add-on, you’re not going to get anywhere near those multiples versus if you’re a platform. If you’re an owner thinking about selling, Geoff’s advice around planning early and we talk about this. It comes up in almost every podcast about preparation and the need for proper preparation and pulling in the right advisors and assessing your tax structure. It’s not how much you get paid for the business, but how much you’re going to keep after all is said and done and making sure that your financial house is in order, not only your P&L but also paying close attention to your balance sheet. Especially if you are a private equity target, they’re going to want to take over a fair amount of your balance sheet, and you need to understand what that is and have a clean balance sheet.
The issues go beyond price, which are indemnifications, reps and warranties, and that’s where having a great advisor like Geoff matters because they can coach you through his market and what to expect. I hope you enjoyed the episode. If you would like to learn more about the process of acquiring or selling a business, please visit us at our website at SunAcquisitions.com or feel free to reach out to me at [email protected]. I look forward to seeing you again in the next episode. Until then, please remember that scaling, acquiring or selling a business takes time, preparation and the proper knowledge.
- Tad Render – Previous Episode
- Miller Cooper
- Good to Great
- [email protected]
- [email protected]
About Geoff Cockrell
Geoff Cockrell is the chair of McGuireWoods Private Equity Group.
He has a wide scope of experience in mergers and acquisitions and financing transactions.
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