Are persistent unrealistic vendor price expectations the dam blocking the flood of deals we might otherwise be seeing? Most private equity practitioners hold that they are.
As buyers and sellers of businesses, private equity firms are both the troublemakers and the sufferers. It’s hard to sympathise with their complaints about high prices and lack of leverage, when they’re refusing to sell their own portfolio companies until the tide turns.
Back from their holidays, the main problem buyout bosses face is where they are going to be able to put to work the vast sums they raised in 2006 and 2007.
The economic downturn that has crept up on the UK could provide some respite to buyout players, and even then only the ones whose existing portfolio companies are sensibly leveraged and defying the gloom.
Corporates, especially those exposed to UK demand, are coming under increasing pressure themselves. Some of them experiencing weakening sales are coming up against their banking covenants, leading their banking syndicates to ask what they are doing sitting on non-core assets.
This is not to suggest that there will be a flood of opportunities for financial buyers, but there is definitely likely to be an uptick in the number of non-core assets coming to market over the next few quarters.
The good news for private equity is that when a corporate is under some sort of pressure to sell, there is scope for negotiation and this is when the much talked about vendor loan note comes into play.
A vendor might well refuse a lower enterprise value, but it might be willing to lend to the buyer, or accept a deferred consideration.
A sponsor will approach the seller saying that at the price attached with the debt quantum offered, he can’t do the deal because his IRR won’t get to its hurdle rate.
By leaving some money in there as a vendor loan note, which must be secured and rank with the senior subordinated debt, the corporate might be able to realise a few hundred million pounds immediately leaving in say £10m–£50m for collection at a later date.
Although not a plain vanilla deal, both buyer and seller ultimately get what they want.
One debt advisory insider observes that for all the press coverage of vendor loan notes and deferred considerations, there have actually been very few such deals, but he expects them to become more of a feature going into Q3 2008 and Q1 2009.
The auction for the business-publishing arm being sold by Reed Elsevier is a point in case. The publisher is believed to be offering £100m of additional debt to whichever private equity firm wins the £1.25bn deal.
Perhaps CVC’s prolonged negotiations with UK insurer Friends Provident will involve a similar sweetener. Friends announced in January that it was looking to sell its wealth management arm Lombard, among other things, but has so far not managed to do so.
News that insurance entrepreneur Clive Cowdery is considering a break-up plan for Friends may trigger a deal with a vendor loan note attached.