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    Guide to private_equity Guide to private_equity Document Transcript

    • A Guide to Private Equity
    • BVCA mission statementThe BVCA represents private equity and venture capital in the UK and is devoted to promoting theprivate equity industry and improving the performance and professional standards of member firmsand the individuals within those firms.
    • Private equity – investing in Britain’s future• Each year UK private equity firms provide several billions of pounds to form, develop and reshape around 1,600 ambitious UK companies with high growth prospects.• Private equity makes managers into owners, giving them the freedom, focus and finance to enable them to revitalise their companies and take them onto their next phase of growth.• Private equity is committed, long-term and risk sharing. It provides companies with personal experience and a stable financial base on which to make strategic decisions.• UK private equity firms offer a wide range of sources, types and styles of private equity to meet many different needs.• A great variety of businesses in different industry sectors benefit from private equity; from high to low technology and in different development stages, from start-up to large established companies. 1
    • PrefaceThe BVCA represents private equity in the UK. Its full members are private equity firms which provide equity funding togrowing unquoted companies and account for over 95% of formal private equity investment in the UK. Associatemembers of the BVCA include firms that provide mezzanine finance, fund of fund managers, secondary purchasers,acquisition finance houses and direct investors into private equity funds, and also lawyers, accountants and otheradvisers experienced in the private equity field, as well as educational or research organisations closely associated withthe private equity industry.The BVCA is devoted to promoting the private equity industry. One of the ways the BVCA achieves this is by providinginformation to those seeking private equity. “A Guide to Private Equity” is a key component in the range of BVCApublications. For further details about other BVCA publications and research see the Appendix on pages 56-58 or theBVCA’s website www.bvca.co.uk.Keith Arundale, of PricewaterhouseCoopers LLP, when advising entrepreneurs on preparing business plans and financeraising, realised that they often viewed the process of how private equity firms appraise business proposals and arriveat their required equity stakes as a mystery. He therefore suggested that the BVCA should have a guide to private equity– so he was duly asked to write it! The first Guide was published in April 1992 and since then many tens of thousands ofcopies have been sent out or downloaded from the BVCA’s website. This new edition has been updated by Keith andthe section on the business plan further enlarged. I would like to thank Keith for initiating the Guide and for hiscontinuing help over the years.I would also like to thank the BVCA Executive and in particular Sarah Eaton for the production of another excellent Guide.Anne GloverBVCA ChairmanOctober 20042
    • ContentsBVCA mission statement Inside front coverPrivate equity – investing in Britain’s future 1Preface 2An introduction to private equity 6 Definition 6 How this Guide can help you 6 What is private equity? 7 Would my company be attractive to a private equity investor? 7 Some of the benefits of private equity 7 Questions to ask yourself before reading further 8 Internal and external financial resources 8 Well-known private equity backed companies 12 The advantages of private equity over senior debt 12 Private equity compared to senior debt 13Sources of private equity 14 Private equity firms 14 Where do private equity firms obtain the money to invest in my business? 14 How may the source of a private equity firm’s money affect me? 14 How do I select the right private equity firm? 15Selecting a private equity firm 16 Targeting 16 Stage/type of investment 16 Industry sector 18 Amount of investment 18 Geographical location 19 3
    • ContentsThe business plan 20 Essential areas to cover in your business plan 20 The presentation of your business plan 28 Things to avoid 29The investment process 30 Reaching your audience 30 Confidentiality 30 How quickly should I receive a response? 30 How do private equity firms evaluate a business plan? 31 Presenting your business plan and negotiations 31 Valuing the business 31 Personal financial commitment 34 Types of financing structure 34 Classes of capital used by private equity firms 34 Other forms of finance provided in addition to equity 36 Additional points to be considered 36 The Offer Letter 37 The due diligence process 37 Syndication 38 Completion 38 Additional private equity definitions 38The role of professional advisers 40 The financial adviser’s role 40 The accountant’s role 41 The lawyer’s role 42 Professional costs 434
    • Your relationship with your investor 45 Private equity for growth and success 45 Hands-on 45 Hands-off 46 Help to avoid the pitfalls 46 Directors’ responsibilities 47 Guidelines for success 47Realising the investment 49 The options 49 Valuing the investment on exit 50Before you do anything – read this! 51 Legal and regulatory issues you must comply with in raising finance 51 The Financial Services and Markets Act 51 Misleading statements 54Appendix – further information 56 Contact details 56 BVCA publications and research 56 Other useful contacts 58 5
    • An introduction to private equityDefinition than many private equity firms are able to invest). In this Guide we principally focus on private equity firms. ThePrivate equity is medium to long-term finance provided attributes that both private equity firms and business angelsin return for an equity stake in potentially high growth look for in potential investee companies are often veryunquoted companies. Some commentators use the term similar and so this Guide should help entrepreneurs and“private equity” to refer only to the buy-out and buy-in their advisers looking for private equity from both theseinvestment sector. Others, in Europe but not the USA, sources. “Corporate venturers” which are industrial oruse the term “venture capital” to cover all stages, i.e. service companies that provide funds and/or a partneringsynonymous with “private equity”. In the USA “venture relationship to fledgling companies and may operate in thecapital” refers only to investments in early stage and same industry sector as your business can also provideexpanding companies. To avoid confusion, the term equity capital.“private equity” is used throughout this Guide todescribe the industry as a whole, encompassing both Throughout the 1990s the technology hype, internet“venture capital” (the seed to expansion stages of boom and massive capital investment propelled theinvestment) and management buy-outs and buy-ins. New Economy revolution, but internet mania in the late 1990s caused technology stocks to skyrocket until theHow this Guide can help you bubble burst in March 2000. There was over-optimism, too much easy money, proven ways of doing businessThis Guide aims to encourage you to approach a source of were replaced by irrational exuberance and private andprivate equity early in your search for finance. It explains public company market valuations were driven tohow the private equity process works and what you need unsustainable levels.to do to improve your chances of raising it. It givesguidance on what should be included in your business Post bubble, in the current economic environment, privateplan, which is a vital tool in your search for funding. It also equity firms are looking for investment opportunitiesdemonstrates the positive advantages that private equity where the business has proven potential for realisticwill bring to your business. growth in an expanding market, backed up by a well- researched and documented business plan and anThe main sources of private equity in the UK are the private experienced management team – ideally includingequity firms (who may invest at all stages – venture capital individuals who have started and run a successfuland buy-outs) and “business angels” (private individuals business before. There is currently no shortage of fundswho provide smaller amounts of finance at an earlier stage6
    • for investment in the UK. Excellent opportunities remain Would my company be attractive to a privateopen to companies seeking private equity with convincing equity investor?business proposals. This Guide will help you to understand Many small companies are “life-style” businesses whosewhat private equity firms are looking for in a potential main purpose is to provide a good standard of living andbusiness investment and how to approach them. job satisfaction for their owners. These businesses are not generally suitable for private equity investment, as theyWhat is private equity? are unlikely to provide the potential financial returns toPrivate equity provides long-term, committed share make them of interest to an external investor.capital, to help unquoted companies grow and succeed. If “Entrepreneurial” businesses can be distinguished fromyou are looking to start up, expand, buy into a business, others by their aspirations and potential for growth, ratherbuy out a division of your parent company, turnaround or than by their current size. Such businesses are aiming torevitalise a company, private equity could help you to do grow rapidly to a significant size. As a rule of thumb,this. Obtaining private equity is very different from raising unless a business can offer the prospect of significantdebt or a loan from a lender, such as a bank. Lenders have turnover growth within five years, it is unlikely to be ofa legal right to interest on a loan and repayment of the interest to a private equity firm. Private equity investorscapital, irrespective of your success or failure. Private are only interested in companies with high growthequity is invested in exchange for a stake in your company prospects, which are managed by experienced andand, as shareholders, the investors’ returns are dependent ambitious teams who are capable of turning their businesson the growth and profitability of your business. plan into reality. However, provided there is real growthPrivate equity in the UK originated in the late 18th century, potential the private equity industry is interested in allwhen entrepreneurs found wealthy individuals to back stages, from start-up to buy-out.their projects on an ad hoc basis. This informal method offinancing became an industry in the late 1970s and early Some of the benefits of private equity1980s when a number of private equity firms were Private equity backed companies have been shownfounded. Private equity is now a recognised asset class. to grow faster than other types of companies. This isThere are over 170 active UK private equity firms, which made possible by the provision of a combination of capitalprovide several billion pounds each year to unquoted and experienced personal input from private equitycompanies, around 80% of which are located in the UK. 7
    • An introduction to private equity continuedexecutives, which sets it apart from other forms of finance. If your answers are “yes”, private equity is worthPrivate equity can help you achieve your ambitions for considering. If “no”, for other sources of capital andyour company and provide a stable base for strategic advice call your local Business Link (see Appendix).decision making. The private equity firms will seek toincrease a company’s value to its owners, without taking Internal and external financial resourcesday-to-day management control. Although you may have Before looking at new external sources of finance,a smaller “slice of cake”, within a few years your “slice” make sure you are making optimal use of your internalshould be worth considerably more than the whole “cake” financial resources.was to you before. • Ensure that you have good cash flow forecastingPrivate equity firms often work in conjunction with other systems in placeproviders of finance and may be able to help you to put atotal funding package together for your business. • Give customers incentives to encourage prompt paymentQuestions to ask yourself before reading • Adhere to rigorous credit control proceduresfurther...• Does your company have high growth prospects • Plan payments to suppliers and are you and your team ambitious to grow your • Maximise sales revenues company rapidly? • Carefully control overheads• Does your company have a product or service with a competitive edge or unique selling point (USP)? • Consider sub-contracting to reduce initial capital requirements (if appropriate)• Do you and/or your management team have relevant industry sector experience? Do you have a clear team • Assess inventory levels (if appropriate) leader and a team with complementary areas of expertise, • Check quality control such as management, marketing, finance, etc? Then think about the external options.• Are you willing to sell some of your company’s shares to a private equity investor? • Your own and your co-directors’ funds8
    • • Friends’ or business associates’ funds The Small Firms Loan Guarantee Scheme allows businesses without sufficient security for commercial bank• The clearing banks – overdrafts, short or lending to obtain loans from participating banks that are medium-term loans guaranteed by the Government. The Small Business• Factoring and invoice discounting Service (SBS) guarantees 75% of the loan. Borrowers pay a 2% premium on the outstanding balance. The maximum• Leasing, hire purchase loan for businesses trading for more than two years is• Merchant banks – medium to long-term larger loans £250,000 or £100,000 for newer businesses.• Public sector grants, loans, regional assistance The scheme is available to UK businesses with an and advice annual turnover of up to £3 million – for manufacturers up to £5 million.• Business angel finance Business Links are part of the SBS and can provide• Corporate venturing advice on the various grants available to small businesses as well as practical advice, help and entry to the various• Private equity schemes run by the Department of Trade and IndustryBut please don’t get the impression that private equity is (DTI). Grant opportunities include grants for research anda last resort after you have exhausted your own, your development, Local Regional Development Agency grantsfriends’, your business colleagues’ and your bank’s and the Phoenix Fund for disadvantaged communities andresources. There are many advantages to private equity groups. New businesses (particularly those using newover bank debt. Private equity firms can of course work technology) can get help with premises and managementin conjunction with the other external sources as part of from the various Business Incubation Centres in the UK oran overall financing package. from one of the UK Science Parks. You may also be eligible for EU grants if you are in an innovative business sector orSome of the alternative sources of external finance are are planning to operate in a deprived area of the UK or aelaborated on below for your information. region zoned for regeneration. Apart from Business Links your local Chamber of Commerce and town hall should have lists of grants and available property. 9
    • An introduction to private equity continuedA new product Selective Finance for Investment in • Offering incentives to investors to make theseEngland has replaced the former Regional Selective investments.Assistance Scheme and is provided by the Regional • Enhancing the impact of business angel networks inDevelopment Agencies. Funding of up to 10-15% of a providing sources of risk capital and expertise to SMEs.project’s total eligible capital expenditure may be obtained. ECFs will be privately managed and invest up to £2 millionThe Regional Venture Capital Funds (RVCFs) are one of equity into an enterprise. A pathfinder round of ECFselement of the £180 million Enterprise Fund that was is to be launched, subject to European state aidscreated in 1998 through the SBS to stimulate more clearance. ECFs will use a limited partnership model withfinance for small businesses and address market weakness two variants.in the provision of that finance. The RVCFs were set up toaddress small to medium enterprises (SMEs) seeking • A professional FSA-authorised fund manager who actssmall-scale investment (i.e. £500,000 and below). The on behalf of passive investors.funds cover the North East, North West, London,Yorkshire and the Humber, South East and South West, • An active investor model (e.g. business angels) whoEast Midlands, West Midlands and East of England. invest and manage own funds through ECFs (maybe without authorisation).The concept of Enterprise Capital Funds (ECFs) is aproposed new UK Government initiative following a Business angels are private investors who invest directlyconsultation process instigated at the 2003 Budget. This in private companies in return for an equity stake andaims to improve access to growth capital for small and perhaps a seat on the company’s board. Research hasmedium-sized enterprises by applying a modified US shown that business angels generally invest smallerSmall Business Investment Company (SBIC) model to amounts of private equity in earlier stage companiesthe UK by: compared with private equity firms. They typically invest less than £100,000 at the seed, start-up and early stage of• Bringing more entrepreneurial investors into the company development. Many companies find business management of funds aimed at smaller, early angels through informal contacts, but for others, finding a stage deals. business angel may be more difficult, as the details of individual business angels are not always available.10
    • The Enterprise Investment Scheme was set up by the corporate venturing is where a corporation invests inGovernment to replace the Business Expansion Scheme private equity funds managed by an independent private(BES) and to encourage business angels to invest in certain equity firm. Corporate venturers raise their funds fromtypes of smaller unquoted UK companies. If a company their parent organisations and/or from external sources.meets the EIS criteria, it may be more attractive to business Do speak to friends, business contacts and advisers asangels, as tax incentives are available on their investments. well as your local Business Link. Do remember there areThe aim of the UK Government’s University Challenge many misconceptions about the various sources ofSeed Fund Scheme is to fill a funding gap in the UK in finance, so obtain as much information as possible tothe provision of finance for bringing university research ensure that you can realistically assess the most suitableinitiatives in science and engineering to the point where finance for your needs and your company’s success.their commercial viability can be demonstrated. Certaincharities and the Government have contributed around£50 million to the scheme. These funds are divided into15 University Challenge Seed Funds that have beendonated to individual universities or consortia and eachone of these has to provide 25% of the total fund from itsown resources. If you are looking into the commercialisationof research at a UK university which is in receipt of a fund,contact your university administration to enquire aboutthe application process. Follow-on finance may beprovided by business angels, corporate venturers andprivate equity firms.Corporate venturing which had developed quite rapidlyin recent years still represents only a small fraction whencompared to private equity investment activity. Directcorporate venturing occurs where a corporation takes adirect minority stake in an unquoted company. Indirect 11
    • An introduction to private equity continued Well-known private equity backed companies defaults on its repayments, the lender can put your business into receivership, which may lead to the Antler liquidation of any assets. A bank may in extreme Benjys circumstances even bankrupt you, if you have given Ben Sherman personal guarantees. Debt which is secured in this way Earls Court & Olympia and which has a higher priority for repayment than that of general unsecured creditors is referred to as “senior debt”. Early Learning Centre Filofax By contrast, private equity is not secured on any assets First Leisure although part of the non-equity funding package provided by the private equity firm may seek some Focus Wickes security. The private equity firm, therefore, often faces Gala Group the risk of failure just like the other shareholders. The Halfords private equity firm is an equity business partner and is Kwik Fit rewarded by the company’s success, generally achieving its principle return through realising a capital Linguaphone gain through an “exit” which may include: Ministry of Sound New Look • Selling their shares back to the management Pinewood – Shepperton Studios • Selling the shares to another investor (such as The AA another private equity firm)The advantages of private equity over • A trade sale (the sale of company shares to another)senior debt • The company achieving a stock market listingA provider of debt (generally a bank) is rewarded by Although private equity is generally provided as part ofinterest and capital repayment of the loan and it is usually a financing package, to simplify comparison we comparesecured either on business assets or your own personal private equity with senior debt.assets, such as your home. As a last resort, if the company12
    • Private equity compared to senior debt Private equity Senior debt Medium to long-term Short to long-term Committed until “exit” Not likely to be committed if the safety of the loan is threatened. Overdrafts are payable on demand; loan facilities can be payable on demand if the covenants are not met. Provides a solid, flexible, capital base to meet your A useful source of finance if the debt to equity ratio future growth and development plans. is conservatively balanced and the company has good cash flow. Good for cash flow, as capital repayment, dividend Requires regular good cash flow to service interest and interest costs (if relevant) are tailored to the and capital repayments. company’s needs and to what it can afford. The returns to the private equity investor depend on the Depends on the company continuing to service its business’ growth and success. The more successful the interest costs and to maintain the value of the assets company is, the better the returns all investors will receive. on which the debt is secured. If the business fails, private equity investors will rank If the business fails, the lender generally has first alongside other shareholders, after the banks and call on the company’s assets. other lenders, and stand to lose their investment. If the business runs into difficulties, the private If the business appears likely to fail, the lender could equity firm will work hard to ensure that the put your business into receivership in order to company is turned around. safeguard its loan, and could make you personally bankrupt if personal guarantees have been given. A true business partner, sharing in your risks and Assistance available varies considerably. rewards, with practical advice and expertise (as required) to assist your business success. 13
    • Sources of private equityThere is a wide range of types and styles of private firms raise their funds for investment from externalequity available in the UK. The primary sources are sources, mainly institutional investors, such as pensionprivate equity firms who may provide finance at all funds and insurance companies, and are known asinvestment stages and business angels who focus on the independents. Private equity firms that obtain theirstart-up and early stages. In targeting prospective funds mainly from their parent organisation are knownsources of finance and business partners, as in any field, as captives. Increasingly, former captives now raiseit works best if you know something about how they funds from external sources as well and are known asoperate, their structure, and their preferences. semi-captives. These different terms for private equity firms now overlap considerably and so are increasinglyPrivate equity firms rarely used.Private equity firms usually look to retain their investment How may the source of a private equity firm’sfor between three and seven years or more. They have a money affect me?range of investment preferences and/or type of financingrequired. It is important that you only approach those Private equity firms’ investment preferences may beprivate equity firms whose preferences match your affected by the source of their funds. Many fundsrequirements. See how to find the right private equity firm raised from external sources are structured as limitedto approach on page 15. partnerships and usually have a fixed life of 10 years. Within this period the funds invest the money committedWhere do private equity firms obtain the to them and by the end of the 10 years they will have hadmoney to invest in my business? to return the investors’ original money, plus any additional returns made. This generally requires the investments toJust as you and your management team are competing be sold, or to be in the form of quoted shares, before thefor finance, so are private equity firms, as they raise their end of the fund. Some funds are structured as quotedfunds from a number of different sources. To obtain Venture and Development Capital Investment Truststheir funds, private equity firms have to demonstrate a (VCITs) and some types of unquoted funds may be able togood track record and the prospect of producing returns offer companies a longer investment horizon.greater than can be achieved through fixed interest orquoted equity investments. Most UK private equity14
    • Venture Capital Trusts (VCTs) are quoted vehicles to the professional advisers listed in the “Associatethat aim to encourage investment in smaller unlisted Members” section.(unquoted and AIM quoted) UK companies by offering As far as a company looking to raise private equity isprivate investors tax incentives in return for a three-year concerned, only those whose investment preferencesinvestment commitment. The first were launched in match your requirements should be approached. PrivateAutumn 1995 and are mainly managed by UK private equity firms appreciate it when they are obviously targetedequity firms. If funds are obtained from a VCT, there after careful consideration.may be some restrictions regarding the company’sfuture development within the first few years. You may find it interesting to obtain a copy of the BVCA’s Report on Investment Activity which analyses theSo How do I select the right private aggregate annual investment activity of the UK privateequity firm? equity industry. It looks at the number of companies backed and the amounts they received by stage,Some private equity firms manage a range of funds industry sector and region.(as described above) including investment trusts, limitedpartnerships and venture capital trusts, and the firms’ You should be mindful of the requirements of theinvestment preferences are listed in the BVCA Directory Financial Services and Markets Act (FSMA) beforeof members. A fully searchable version of the Directory is you communicate a business plan to potential investors.available free of charge to those seeking private equity See pages 51-55.investment on www.bvca.co.uk. It lists private equityfirms, their investment preferences and contact details. It The next chapter will take you through the selectionalso lists financial organisations, such as mezzanine firms, process in more detail.fund of funds managers and professional advisers, suchas accountants and lawyers, who are experienced in theprivate equity field. Your advisers may be able tointroduce you to their private equity contacts and assistyou in selecting the right private equity firm. If they donot have suitable contacts or cannot assist you in seekingprivate equity, obtain a copy of the Directory and refer 15
    • Selecting a private equity firmTargeting Seed To allow a business concept to be developed, perhapsThe most effective way of raising private equity is to involving the production of a business plan, prototypesselect just a few private equity firms to target with your and additional research, prior to bringing a product tobusiness proposition. market and commencing large-scale manufacturing.The key considerations should be to assess: Only a few seed financings are undertaken each year1. The stage of your company’s development or the by private equity firms. Many seed financings are too type of private equity investment required. small and require too much hands-on support from the private equity firm to make them economically viable as2. The industry sector in which your business investments. There are, however, some specialist private operates. equity firms which are worth approaching, subject to3. The amount of finance your company needs. the company meeting their other investment preferences. Business angel capital should also be4. The geographical location of your business considered, as with a business angel on a company’s operations. board, it may be more attractive to private equity firmsYou should select only those private equity firms when later stage funds are required.whose investment preferences match these attributes. Start-upThe BVCA Directory of members specifies their To develop the company’s products and fund their initialinvestment preferences and contact details. It also marketing. Companies may be in the process of beingincludes the names of some of the companies in which set up or may have been trading for a short time, but notthey have invested. have sold their product commercially.1. Stage/type of investment Although many start-ups are typically smaller companies, there is an increasing number of multi-million poundThe terms that most private equity firms use to define start-ups. Around half of BVCA members will considerthe stage of a company’s development are determined high quality and generally larger start-up propositions.by the purpose for which the financing is required. However, there are those who specialise in this stage,16
    • subject to the company seeking investment meeting the MBOs range from the acquisition of relatively smallfirm’s other investment preferences. Around 15% of formerly family owned businesses to £100 million pluscompanies receiving private equity each year are start-ups. buy-outs. The amounts concerned tend to be larger than other types of financing, as they involve theOther early stage acquisition of an entire business. They tend to accountTo initiate commercial manufacturing and sales in for around 15% of financings undertaken each year bycompanies that have completed the product development BVCA member companies.stage, but may not yet be generating profits. Management buy-in (MBI)This is a stage that has been attracting an increasing To enable a manager or group of managers from outsideamount of private equity over the past few years, a company to buy into it.accounting for around 20% of the number of financingseach year by BVCA members. Buy-in management buy-out (BIMBO) To enable a company’s management to acquire theExpansionTo grow and expand an established company. For business they manage with the assistance of someexample, to finance increased production capacity, incoming management.product development, marketing and to provide Institutional buy-out (IBO)additional working capital. Also known as “development” To enable a private equity firm to acquire a company,or “growth” capital. following which the incumbent and/or incomingMore UK companies at this stage of development management will be given or acquire a stake inreceive private equity than any other, generally the business.accounting for around 50% of financings each year by This is a relatively new term and is an increasingly usedBVCA members. method of buy-out. It is a method often preferred byManagement buy-out (MBO) vendors, as it reduces the number of parties with whomTo enable the current operating management and they have to negotiate.investors to acquire or to purchase a significantshareholding in the product line or business they manage. 17
    • Selecting a private equity firm continuedSecondary purchase 3. Amount of investmentWhen a private equity firm acquires existing shares in a Around 80% of UK private equity firms’ financings eachcompany from another private equity firm or from year are for amounts of over £100,000 per company.another shareholder or shareholders. There are, however, a number of private equity firmsReplacement equity who will consider investing amounts of private equityTo allow existing non-private equity investors to buy back under £100,000 and these tend to include specialist andor redeem part, or all, of another investor’s shareholding. regionally orientated firms. Companies initially seeking smaller amounts of private equity are more attractive toRescue/turnaround private equity firms if there is an opportunity for furtherTo finance a company in difficulties or to rescue it from rounds of private equity investment later on.receivership. The process for investment is similar, whether the amountRefinancing bank debt of capital required is £100,000 or £10 million, in terms ofTo reduce a company’s level of gearing. the amount of time and effort private equity firms have to spend in appraising the business proposal prior toBridge financing investment. This makes the medium to larger-sizedShort-term private equity funding provided to a investments more attractive for private equity investment,company generally planning to float within a year. as the total size of the return (rather than the percentage) is likely to be greater than for smaller investments, and2. Industry sector should more easily cover the initial appraisal costs.Most private equity firms will consider investing in a Business angels are perhaps the largest source ofrange of industry sectors – if your requirements meet smaller amounts of equity finance, often investingtheir other investment preferences. Some firms amounts ranging between £10,000 and £100,000 inspecialise in specific industry sectors, such as early stage and smaller expanding companies.biotechnology, computer related and other technologyareas. Others may actively avoid sectors such asproperty or film production.18
    • 4. Geographical locationSeveral private equity firms have offices in the UKregions. Some regions are better served with more localprivate equity firms than others, but there are also manyfirms, particularly in London, who look to invest UK-wide.Over 20% of total investment is outside the UK andseveral private equity firms have offices located abroad. 19
    • The business planA business plan’s main purpose when raising finance is Professional advisers can provide a vital role in criticallyto market your business proposal. It should show reviewing the draft plan, acting as “devil’s advocate” andpotential investors that if they invest in your business, helping to give the plan the appropriate focus. Severalyou and your team will give them a unique opportunity of the larger accounting firms publish their own detailedto participate in making an excellent return. booklets on how to prepare business plans. However, it is you who must write the plan as private equity firmsA business plan should be considered an essential generally prefer management driven plans, such as aredocument for owners and management to formally illustrated in this chapter.assess market needs and the competition; review thebusiness’ strengths and weaknesses; and to identify its Essential areas to cover in your business plancritical success factors and what must be done toachieve profitable growth. It can be used to consider Many businesses fail because their plans have not beenand reorganise internal financing and to agree and set properly thought out, written down and developed. Atargets for you and your management team. It should be business plan should be prepared to a high standardreviewed regularly. and be verifiable. A business plan covering the following areas should be prepared before a private equity firmThe company’s management should prepare the is approached.business plan. Its production frequently takes far longerthan the management expects. The owner or the Executive Summarymanaging director of the business should be the one This is the most important section and is often bestwho takes responsibility for its production, but it should written last. It summarises your business plan and isbe “owned” and accepted by the management team as a placed at the front of the document. It is vital to give thiswhole and be seen to set challenging but achievable summary significant thought and time, as it may wellgoals that they are committed to meeting. It should determine the amount of consideration the privateemphasise why you are convinced that the business will equity investor will give to your detailed proposal. Itbe successful and convey what is so unique about it. should be clearly written and powerfully persuasive, yetPrivate equity investors will want to learn what you and balance “sales talk” with realism in order to be convincing.your management are planning to do, not see how wellothers can write for you.20
    • It needs to be convincing in conveying your company’s explain the current legal status of your business in thisgrowth and profit potential and management’s prior section. You should include an overall “SWOT” (strengths,relevant experience. It needs to clearly encapsulate your weaknesses, opportunities and threats) analysis thatcompany’s USP (i.e. its unique selling point – why summarises the key strengths of your proposition and itspeople should buy your product or service as distinct weaknesses and the opportunities for your business in thefrom your competitors). marketplace and its competitive threats.The summary should be limited to no more than two to 1. The marketthree pages (i.e. around 1,000 to 1,500 words) and You need to convince the private equity firm that thereinclude the key elements from all the points below: is a real commercial opportunity for the business and its products and services. This requires a careful analysis of1. The market the market potential for your products or services and2. The product or service how you plan to develop and penetrate the market.3. The management team Market analysis4. Business operations This section of the business plan will be scrutinised carefully; market analysis should therefore be as specific5. Financial projections as possible, focusing on believable, verifiable data. Include under market research a thorough analysis of6. Amount and use of finance required and exit your company’s industry and potential customers. opportunities Include data on the size of the market, growth rates,Other aspects that should be included in the Executive recent technical advances, Government regulations andSummary are your company’s “mission statement” – a few trends – is the market as a whole developing, growing,sentences encapsulating what the business does for what mature, or declining? Include details on the number oftype of clients, the management’s aims for the company potential customers, the purchase rate per customer, andand what gives it its competitive edge. The mission a profile of the typical decision-maker who will decidestatement should combine the current situation with your whether to purchase your product or service. Thisaspirations. For an example, see the BVCA’s own mission information drives the sales forecast and pricing strategystatement on the inside front cover. You should also in your plan. Finally, comment on the percentage of the 21
    • The business plan continuedtarget market your company plans to capture, with • Distribution channelsjustification in the marketing section of the plan. If you are a manufacturer, your business plan should clearly identify the distribution channels that will getMarketing plan the product to the end-user. If you are a serviceThe primary purpose of the marketing section of the provider, the distribution channels are not asbusiness plan is for you to convince the private equity important as are the means of promotion. Distributionfirm that the market can be developed and penetrated. options for a manufacturer may include:The sales projections that you make will drive the rest ofthe business plan by estimating the rate of growth of - Distributorsoperations and the financing required. Explain your - Wholesalersplans for the development of the business and how youare going to achieve those goals. Avoid using generalised - Retailers (including on-line)extrapolations from overall market statistics. - Direct sales – such as mail order and orderingThe plan should include an outline of plans for pricing, over the web, direct contact through salespeopledistribution channels and promotion. and telemarketing.• Pricing - Original Equipment Manufacturers (OEM), How you plan to price a product or service provides integration of the product into other an investor with insight for evaluating your overall manufacturers’ products. strategy. Explain the key components of the pricing Each of these methods has its own advantages, decision – i.e. image, competitive issues, gross disadvantages and financial impact, and these should margins, and the discount structure for each be clarified in the business plan. For example, distribution channel. Pricing strategy should also assume your company decides to use direct sales involve consideration of future product releases. because of the expertise required in selling the product. A direct salesforce increases control, but it requires a significant investment. An investor will look to your expertise as a salesperson, or to the plans to hire, train and compensate an expert22
    • salesforce. If more than one distribution channel is Competition used, they should all be compatible. For example, A discussion of the competition is an essential part of using both direct sales and wholesalers can create the business plan. Every product or service has channel conflict if not managed well. competition; even if your company is first-to-market, you must explain how the market’s need is currently Fully explain the reasons for selecting these being met and how the new product will compete distribution approaches and the financial benefits against the existing solution. The investor will be looking they will provide. The explanation should include a to see how and why your company can beat the schedule of projected prices, with appropriate competition. The business plan should analyse the discounts and commissions as part of the projected competition (who are they, how many are there, what sales estimates. These estimates of profit margin proportion of the market do they account for?). Give and pricing policy will provide support for the their strengths and weaknesses relative to your product. investment decision. Attempt to anticipate likely competitive responses to• Promotion your product. Include, if possible, a direct product The marketing promotion section of the business comparison based on price, quality, warranties, product plan should include plans for product sheets, updates, features, distribution strategies, and other potential advertising plans, internet strategy, trade means of comparison. Document the sources used in show schedules, and any other promotional materials. this analysis. The private equity firm must be convinced that the company has the expertise to move the product to All the aspects included in the market section of your market. A well-thought-out promotional approach business plan must be rigorously supported by as much will help to set your business plan apart from verifiable evidence as possible. In addition to carrying your competitors. out market research and discussions with your management team, customers and potential customers, It is important to explain the thought process behind you may need input from outside marketing consultants. the selected sources of promotion and the reasons for those not selected. 23
    • The business plan continued2. The product or service • If relevant, explain what legal protection you have onExplain the company’s product or service in plain the product, such as patents attained, pending orEnglish. If the product or service is technically orientated required. Assess the impact of legal protection onthis is essential, as it has to be readily understood by the marketability of the product.non-specialists. • You also need to cover of course the price and costEmphasise the product or service’s competitive edge or of the product or service.USP. For example, is it: • If the product is still under development the plan• A new product? should list all the major achievements to date as well as remaining milestones to demonstrate how you• Available at a lower price? have tackled various hurdles and that you are aware• Of higher quality? of remaining hurdles and how to surmount them. Specific mention should be made of the results of• Of greater durability? alpha (internal) and beta (external) product testing.• Faster to operate? • Single product companies can be a concern for• Smaller in size? investors. It is beneficial to include ideas and plans for a “second generation” product or even other• Easier to maintain? viable products or services to demonstrate the opportunities for business growth.• Offering additional support products or services?With technology companies where the product or 3. The management teamservice is new, there has to be a clear “world class” Private equity firms invest in people – people who haveopportunity to balance the higher risks involved. run or who are likely to run successful operations.Address whether it is vulnerable to technological Potential investors will look closely at you and theadvances made elsewhere. members of your management team. This section of the plan should introduce the management team and what you all bring to the business. Include your experience, and success, in running businesses before and how you24
    • have learned from not so successful businesses. You • Explain what controls and performance measuresneed to demonstrate that the company has the quality exist for management, employees and others.of management to be able to turn the business plan • List your auditors and other advisers.into reality. • The appointment of a non-executive director (NED)The senior management team ideally should be should be seriously considered. Many surveys haveexperienced in complementary areas, such as shown that good NEDs add significant value to themanagement strategy, finance and marketing and their companies with which they are involved. Manyroles should be specified. The special abilities each private equity firms at the time of their investmentmember brings to the venture should be explained. will wish to appoint one of their own executives orThis is particularly the case with technology companies an independent expert to your board as an NED.where it will be the combination of technological and Most private equity executives have previouslybusiness skills that will be important to the backers. If worked in industry or in finance and all will have asome members have particular flair and dynamism, this wide experience of companies going through a rapidneeds to be balanced by those who can ensure this period of growth and development.occurs in a controlled environment. The BVCA’s annual survey of the Economic Impact ofA concise curriculum vitae should be included for each Private Equity reveals that generally over three-quartersteam member, highlighting their previous track records in of the private equity backed companies feel that therunning, or being involved with successful businesses. private equity firms make a major contribution other• Identify the current and potential skills’ gaps and than the provision of money. Contributions cited by explain how you aim to fill them. Private equity private equity backed companies include private firms will sometimes assist in locating experienced equity firms being used to provide financial advice, managers where an important post is unfilled – guidance on strategic matters, for management provided they are convinced about the other aspects recruitment purposes as well as for their contacts and of your plan. market information. 25
    • The business plan continued4. Business operations • Are there suppliers who can provide the materialsThis section of the business plan should explain how required?your business operates, including how you make the • Is there an educated work force in the area?products or provide the service. It should also outlineyour company’s approach to research and development. These and any other operational factors that might be important to the investor should be included.Include details on the location and size of your facilities.Factors such as the availability of labour, accessibility of 5. Financial projectionsmaterials, proximity to distribution channels, and the Developing a detailed set of financial projections willavailability of Government grants and tax incentives help to demonstrate to the investor that you haveshould be mentioned. Describe the equipment used or properly thought out the financial implications of yourplanned. If more equipment is required in response to company’s growth plans. Private equity firms will useproduction demands, include plans for financing. If your these projections to determine if:company needs international distribution, mentionwhether the operations facility will provide adequate • Your company offers enough growth potential tosupport. If work will be outsourced to subcontractors – deliver the type of return on investment that theeliminating the need to expand facilities – state that investor is seeking.too. The investor will be looking to see if there are • The projections are realistic enough to give theinconsistencies in your business plan. company a reasonable chance of attaining them.If a prototype has not been developed or there is other Investors will expect to see a full set of cohesive financialuncertainty concerning production, include a budget statements – including a balance sheet, income statementand timetable for product development. The private and cash-flow statement, for a period of three to fiveequity firm will be looking to see how flexible and years. It is usual to show monthly income and cash flowefficient the facility plans are. statements until the breakeven point is reached followedThe private equity firm will also ask such questions as: by yearly data for the remaining time frame. Ensure that these are easy to update and adjust. Do include notes• If sales projections predict a growth rate of 25% per that explain the major assumptions used to develop the year, for example, does the current site allow for expansion?26
    • revenue and expense items and explain the research ensure that key factors and their impact on theyou have undertaken to support these assumptions. financings required are carefully and realistically assessed. For example, what if sales decline by 20%,Preparation of the projections or supplier costs increase by 30%, or both? How does• Realistically assess sales, costs (both fixed and this impact on the profit and cash flow projections? variable), cash flow and working capital. Assess your present and prospective future margins in detail, • If it is envisioned that more than one round of bearing in mind the potential impact of competition. financing will be required (often the case with technology-based businesses in particular), identify• Assess the value attributed to the company’s net the likely timing and any associated progress tangible assets. “milestones” which need to be achieved.• State the level of gearing (i.e. debt to shareholders’ • Keep the plan feasible. Avoid being over optimistic. funds ratio). State how much debt is secured on Highlight challenges and show how they will be met. what assets and the current value of those assets. You might wish to consider using an external accountant• Include all costs associated with the business. to review the financial projections and act as “devil’s Remember to split sales costs (e.g. communications advocate” for this part of the plan. to potential and current customers) and marketing costs (e.g. research into potential sales areas). What 6. Amount and use of finance required and exit are the sale prices or fee charging structures? opportunities State how much finance is required by your business• Provide budgets for each area of your company’s and from what sources (i.e. management, private activities. What are you doing to ensure that you and equity firm, banks and others) and explain for what it your management keep within these or improve on will be used: these budgets? • Include an implementation schedule, including• Present different scenarios for the financial capital expenditure, orders and production timetables, projections of sales, costs and cash flow for both the for example. short and long term. Ask “what if?” questions to 27
    • The business plan continued• Consider how the private equity investors will make • Length a return, i.e. realise their investment (see page 49). The length of your business plan depends on This may only need outlining if you are considering individual circumstances. It should be long enough floating your company on a stock exchange within to cover the subject adequately and short enough to the next few years. However, it is important that maintain interest. For a multi-million pound technology the options are considered and discussed with company with sophisticated research and manufacturing your investors. elements, the business plan could be well over 50 pages including appendices. By contrast, a proposalThe presentation of your business plan for £200,000 to develop an existing product may be too long at 10 pages. It is probably best to err on theBear the following points in mind when you are writing side of brevity – for if investors are interested theyyour business plan. can always call you to ask for additional information.• Readability Unless your business requires several million pounds Make the plan readable. Avoid jargon and general of private equity and is highly complex, we would position statements. Use plain English – especially if recommend the business plan should be no longer you are explaining technical details. Aim it at non- than 15 pages. specialists, emphasising its financial viability. Avoid • Appearance including unnecessary detail and prevent the plan Use graphs and charts to illustrate and simplify from becoming too lengthy. Put detail into appendices. complicated information. Use titles and sub-titles to Ask someone outside the company to check it for divide different subject matters. Ensure it is neatly typed clarity and “readability”. Remember that the readers or printed without spelling, typing or grammar mistakes targeted will be potential investors. They will need to – these have a disproportionately negative impact. Yet be convinced of the company’s commercial viability avoid very expensive documentation, as this might and competitive edge and will be particularly looking suggest unnecessary waste and extravagance. to see the potential for making a good return.28
    • Things to avoid!On a lighter note, the following signs of extravaganceand non-productive company expenditure are likely todiscourage a private equity firm from investing and soare best avoided.Things to avoid Flashy, expensive cars Company yacht/plane Personalised number plate Carpets woven with the company logo Company flag pole Fountain in the forecourt “International” in your name (unless you are!) Fish tank in the board room Founder’s statue in reception 29
    • The investment processThe investment process, from reviewing the business supplied to them by companies looking for private equityplan to actually investing in a proposition, can take a capital (or indeed in which they have invested). There areprivate equity firm anything from one month to one year safeguards you can take, however, if you are particularlybut typically it takes between three and six months. concerned about confidentiality. These include:There are always exceptions to the rule and deals can be • Seeking professional advicedone in extremely short time frames. Much depends onthe quality of information provided and made available • Checking whether the potential investor has anyto the private equity firm. major conflicts of interest, such as a significant investment in a competitorReaching your audience • Leaving out the more confidential dataWhen you have fully prepared the business plan and • Sending only your Executive Summaryreceived input from your professional adviser, thenext step is to arrange for it to be reviewed by a few • Using the BVCA’s standard confidentiality letterprivate equity firms. You should select only those private If you wish to use a confidentiality letter, an example ofequity firms whose investment preferences match the one can be obtained from the BVCA’s website. Theinvestment stage, industry, location of, and amount of general terms of this letter have been agreed by BVCAequity financing required by your business proposition. members and with your lawyer’s advice you can adaptFor the initial approach, it is worth considering sending it to meet your own requirements. You can then ask theonly a copy of the Executive Summary to potential private equity investor to sign it, before being sent theinvestors. This has the advantage of saving costs and full business plan. We would recommend, however,increasing the chances of receiving attention. Before that you only ask for a confidentiality letter when thecommunicating your plan to potential investors, read potential investor has received your Executive Summarypages 51-55 concerning the FSMA requirements. and has shown an interest in giving your proposal detailed consideration.ConfidentialityAll private equity firms who are members of the BVCA How quickly should I receive a response?are bound by the BVCA’s “Code of Conduct” which Generally you should receive an initial indication fromstates that they will respect confidential information the private equity firms that receive your business30
    • plan within a week or so. This will either be a prompt management team are able to present the business plan“no”, a request for further information, or a request for convincingly and demonstrate a thorough knowledge anda meeting. If you receive a “no”, try to find out the understanding of all aspects of the business, its market,reasons as you may have to consider incorporating operation and prospects.revisions into your business plan, changing/strengthening Assuming a satisfactory outcome of the meeting andthe management team or carrying out further market further enquiries, the private equity firm will commenceresearch before approaching other potential investors. discussions regarding the terms of the deal with you. The first step will be to establish the value of your business.How do private equity firms evaluate abusiness plan? Valuing the businessThey will consider several principal aspects: There is no right or wrong way of valuing a business.• Is the product or service commercially viable? There are several ways in which it can be done.• Does the company have potential for sustained Calculate the value of the company in comparison with the growth? values of similar companies quoted on the stock market.• Does management have the ability to exploit this The key to this calculation is to establish an appropriate potential and control the company through the price/earnings (P/E) ratio for your company. The P/E growth phases? ratio is the multiple of profits after tax attributed to a company to establish its capital value. P/E ratios for• Does the possible reward justify the risk? quoted companies are listed in the back pages of the• Does the potential financial return on the investment Financial Times, and are calculated by dividing the meet their investment criteria? current share price by historic post-tax earnings per share. Quoted companies’ P/E ratios will vary accordingPresenting your business plan and negotiations to industry sector (its popularity and prospects), company size, investors’ sentiments towards it, itsIf a private equity firm is interested in proceeding further, management and its prospects, and can also be affectedyou will need to ensure that the key members of the by the timing of year-end results announcements. 31
    • The investment process continuedThe private equity investment process32
    • An unquoted company’s P/E ratio will tend to be lower Calculate a value for your company that will give thethan a quoted company’s due to the following reasons. private equity firms their required rate of return over the period they anticipate being shareholders.• Its shares are less marketable and shares cannot be bought and sold at will. Private equity firms usually think in terms of a target overall return from their investments. Generally “return”• It often has a higher risk profile, as there may be less refers to the annual internal rate of return (IRR), and is diversification of products and services and a calculated over the life of the investment. The overall narrower geographical spread. return takes into account capital redemptions, possible• It generally has a shorter track record and a less capital gains (through a total “exit” or sale of shares), experienced management team. and income through fees and dividends. The returns required will depend on the perceived risk of the• The cost of making and monitoring a private equity investment – the higher the risk, the higher the return investment is much higher. that will be sought – and it will vary considerablyThe following are factors that may raise an unquoted according to the sector and stage of the business. As acompany’s P/E ratio compared with a quoted company. rough guide, the average return required will exceed 20% per annum.• Substantially higher than normal projected turnover and profits growth. The required IRR will depend on the following factors.• Inclusion in a fashionable sector, or ownership of • The risk associated with the business proposal. unique intellectual property rights (IPR). • The length of time the private equity firm’s money• Competition among private equity firms. will be tied up in the investment. • How easily the private equity firm expects to realise its investment – i.e. through a trade sale, public flotation, etc. • How many other private equity firms are interested in the deal (i.e. the competition involved). 33
    • The investment process continuedOther methods your company depends on the general style of the firmPrivate equity firms also use other ways of valuing and on what you have agreed with them.businesses, such as those based on existing net assets There are various ways in which the deal can be financedor their realisable value. and these are open to negotiation. The private equity firm will put forward a proposed structure for considerationPersonal financial commitment by you and your advisers that will be tailored to meet theYou and your team must have already invested, or be company’s needs. The private equity firm may also offerprepared to invest, some of your own capital in your to provide more finance than just pure equity capital,company to demonstrate a personal financial such as debt or mezzanine finance. In any case, shouldcommitment to the venture. After all, why should a additional capital be required, with private equity onprivate equity firm risk its money, and its investors’, if board other forms of finance are often easier to raise.you are not prepared to risk your own! The proportion The structure proposed may include a package of someof money you and your team should invest depends on or all of the following elements.what is seen to be “material” to you, which is verysubjective. This could mean re-mortgaging your house, Classes of capital used by private equity firmsfor example. The main classes of share and loan capital used to finance UK limited liability companies are shown below.Types of financing structureIf you use advisers experienced in the private equity Share capitalfield, they will help you to negotiate the terms of the The structure of share capital that will be developedequity deal. You must be prepared to give up a realistic involves the establishment of certain rights. The privateportion of the equity in your business if you want to equity firm through these rights will try to balance thesecure the financing. Whatever percentage of the risks they are taking with the rewards they are seeking.shares you sell, the day-to-day operations will remain They will also be aiming to put together a package thatthe responsibility of you and your management team. best suits your company for future growth. TheseThe level of a private equity firm’s involvement with structures require the assistance of an experienced qualified legal adviser.34
    • Ordinary shares entitled to a fixed dividend (e.g. 10% fixed). The sharesThese are equity shares that are entitled to all income may be redeemable on fixed dates or they may beand capital after the rights of all other classes of capital irredeemable. Sometimes they may be redeemable at aand creditors have been satisfied. Ordinary shares have fixed premium (e.g. at 120% of cost). They may bevotes. In a private equity deal these are the shares convertible into a class of ordinary shares.typically held by the management and familyshareholders rather than the private equity firm. Loan capital Loan capital ranks ahead of share capital for bothPreferred ordinary shares income and capital. Loans typically are entitled toThese may also be known as “A” ordinary shares, interest and are usually, though not necessarily,cumulative convertible participating preferred ordinary repayable. Loans may be secured on the company’sshares or cumulative preferred ordinary shares. These assets or may be unsecured. A secured loan will rankare equity shares with preferred rights. Typically they ahead of unsecured loans and certain other creditors ofwill rank ahead of the ordinary shares for both income the company. A loan may be convertible into equityand capital. Once the preferred ordinary share capital shares. Alternatively, it may have a warrant attached thathas been repaid and then the ordinary share capital has gives the loan holder the option to subscribe for newbeen repaid, the two classes would then rank pari passu equity shares on terms fixed in the warrant. Theyin sharing any surplus capital. Their income rights may typically carry a higher rate of interest than bank termbe defined; they may be entitled to a fixed dividend (a loans and rank behind the bank for payment of interestpercentage linked to the subscription price, e.g. 8% and repayment of capital.fixed) and/or they may have a right to a defined share ofthe company’s profits – known as a participating dividend(e.g. 5% of profits before tax). Preferred ordinary shareshave votes.Preference sharesThese are non-equity shares. They rank ahead of allclasses of ordinary shares for both income and capital.Their income rights are defined and they are usually 35
    • The investment process continuedOther forms of finance provided in addition Mezzanine firms – provide loan finance that is halfwayto equity between equity and secured debt. These facilities require either a second charge on the company’s assetsClearing banks – principally provide overdrafts and or are unsecured. Because the risk is consequentlyshort to medium-term loans at fixed or, more usually, higher than senior debt, the interest charged by thevariable rates of interest. mezzanine debt provider will be higher than that fromInvestment banks – organise the provision of medium the principal lenders and sometimes a modest equityto longer-term loans, usually for larger amounts than “up-side” will be required through options or warrants.clearing banks. Later they can play an important role in It is generally most appropriate for larger transactions.the process of “going public” by advising on the termsand price of public issues and by arranging underwriting Additional points to be consideredwhen necessary. By discussing a mixture of the above forms of finance, aFinance houses – provide various forms of instalment deal acceptable to both management and the privatecredit, ranging from hire purchase to leasing, often equity firm can usually be negotiated. Other negotiatingasset based and usually for a fixed term and at fixed points are often:interest rates. • Whether the private equity firm requires a seat onFactoring companies – provide finance by buying the company’s board of directors or wishes totrade debts at a discount, either on a recourse basis (you appoint an independent director.retain the credit risk on the debts) or on a non-recourse • What happens if agreed targets are not met andbasis (the factoring company takes over the credit risk). payments are not made by your company?Government and European Commission sources – • How many votes are to be ascribed to the privateprovide financial aid to UK companies, ranging from equity firm’s shares?project grants (related to jobs created and safeguarded)to enterprise loans in selective areas. See pages 9-11. • The level of warranties and indemnities provided by the directors.36
    • • Whether there is to be a one-off fee for completing Chartered accountants are often called on to do much of the deal and how much this will be? the due diligence, such as to report on the financial projections and other financial aspects of the plan. These• Who will bear the costs of the external due diligence reports often follow a detailed study, or a one or two day process? overview may be all that is required by the private equity firm. They will assess and review the following pointsThe Offer Letter concerning the company and its management:At this point, the private equity firm will send you an • Management information systemsOffer Letter, which sets out the general terms of theproposal, subject to the outcome of the due diligence • Forecasting techniques and accuracy of pastprocess and other enquiries and the conclusion of the forecastingnegotiations. The Offer Letter, without being legally • Assumptions on which financial assumptionsbinding on either party, demonstrates the investor’s are basedcommitment to management’s business plan and showsthat serious consideration is being given to making • The latest available management accounts, includingan investment. the company’s cash/debtor positions • Bank facilities and leasing agreementsThe due diligence processTo support an initial positive assessment of your • Pensions fundingbusiness proposition, the private equity firm will want to • Employee contracts, etcassess the technical and financial feasibility in detail. This review aims to support or contradict the privateExternal consultants are often used to assess market equity firm’s own initial impressions of the business planprospects and the technical feasibility of the proposition, formed during the initial stage. References may also beunless the private equity firm has the appropriately taken up on the company (e.g. with suppliers, customers,qualified people in-house. and bankers) and on the individual members of the management team (e.g. previous employers). The 37
    • The investment process continuedchartered accountancy firm may also be able to provide • Avoids any one investor having a major equity shareadvice on the key commercial and structural risks facing and significant unilateral control over the business.the business and to carry out assessments on the company’s • Makes available the combined business experiencetechnology base and intellectual property. of all the private equity partners to the benefit ofIf the private equity firm commissions external advisers, the company.it usually means that they are seriously considering • Permits a relatively greater amount of financing thaninvesting in your business. The due diligence process is with a single investor.used to sift out any skeletons or fundamental problemsthat may exist. Make the process easier (and therefore • Can offer more sources of additional future financing.less costly) for you and the private equity firm by notkeeping back any information of which you think they And finally, completionshould be aware in arriving at a decision. In any event,you will have to warrant this in due course. Once the due diligence is complete, the terms of the deal can be finally negotiated and, once agreed by all parties, the lawyers will draw up Heads of AgreementSyndication or Agreement in Principle and then the legally bindingWhen the amount of funding required is particularly completion documents. Management should ensurelarge, or when the investment is considered to be that they both take legal advice and have a firm grasprelatively high risk, the private equity firm may consider themselves of all the legalities within the documents. Thesyndicating the deal. legal documentation is described in the next chapter.Syndication is where several private equity firmsparticipate in the deal, each putting in part of the total Additional private equity definitionsequity package for proportionate amounts of equity, Burn rateusually with one private equity firm acting as lead The rate at which a company requires additional cash toinvestor. Whilst syndication is of benefit to the private keep going.equity firm in limiting risk in the venture, it can also haveadvantages for the entrepreneur as syndication:38
    • Chinese walls RatchetsArrangements that prevent sensitive information A structure whereby the eventual equity allocationsbeing passed between different parts of the same between the groups of shareholders depend on eitherorganisation, to prevent a conflict of interest or breach the future performance of the company or the rate ofof confidentiality. return achieved by the private equity firm. This allows management shareholders to increase their stake if theDividend cover company performs particularly well.Calculated by dividing earnings after tax by the netdividend and expressed as a multiple. It shows how Yieldmany times a company’s dividends are covered by post- Calculated by dividing the gross dividend by the sharetax earnings. price and expressed as percentage. It shows the annual return on an investment from interest and dividends,Earn-out excluding any capital gain element.Part of the price of a transaction, which is conditional onthe performance of the company following the deal.Gearing, debt/equity ratio or leverageThe total borrowings of a company expressed as apercentage of shareholders’ funds.IPOInitial Public Offering, “flotation”, “float”, “going public”,“listing” are just some of the terms used when acompany obtains a quotation on a stock market. Stockmarkets include the Official List of the London StockExchange (where around 40% of trading companyflotations are venture backed), the AlternativeInvestment Market (AIM), NASDAQ Europe, NASDAQ(USA) and other overseas exchanges. 39
    • The role of professional advisersThe financial adviser, accountant and lawyer have • Advice on valuation of the business and planning forimportant roles to play in the private equity process, the ultimate sale of the business and realisation ofboth for the management team seeking finance and the management and the private equity firm’s investment.private equity firm. It is often the case that the financial • Undertaking financial modelling – carrying out sensitivityadvisory role and the role of the accountant performing analysis on the financial projections to establish thatinvestigatory due diligence are performed by different the forecasts make accounting and commercialteams within the same organisation. Your accountant sense. Checking that they have been prepared inmay therefore be able to act as your financial adviser. accordance with reasonable accounting policies andThe financial adviser’s role with due regard to publicly available information.The primary role of the financial adviser in an MBO • Advice on the most appropriate capital structure totransaction is to provide corporate finance advice to be used to fund your proposal.either the management team or the private equity firm • Making introductions to appropriate sources of privatesponsoring the transaction. Your financial adviser will equity with investment criteria that match yourprovide you with impartial financial advice, independent business proposition and a business style that shouldof the private equity firm and its own advisers. The be right for you. If your business is a highly attractiveprecise nature of the role varies from situation to investment opportunity for private equity firms, thissituation but typically includes: may include organising an “auction” or a “beauty• Undertaking an initial appraisal of management’s parade” of private equity firms to compete for the right financing proposition. to finance your company. The financial adviser will need to ensure that the terms of the FSMA – see• Advice on your business plan – critically reviewing pages 51-55 – are properly complied with in providing and appraising your plan to ensure that it includes all this service. the areas referred to in the business plan section of this Guide and that the business plan is framed and • Making introductions to appropriate sources of debt presented in accordance with the requirements of and other finance to help to fund the proposal. the private equity firms.40
    • • Reviewing offers of finance – reviewing the terms of benefit of both management and the private the deal offered by the private equity firms and other equity firm. finance providers and assisting in negotiating the • Undertaking pensions, IT or environmental most advantageous terms from those on offer. investigatory work and due diligence.• Assisting in negotiating the terms of the deal with the • Providing audit, accounting and other advisory private equity firms and banks and with the vendor. services.• Project managing the transaction to minimise calls on • Planning your tax efficiently – help management management time and disruption to the business. obtain the maximum benefit from the tax system,• Providing other advice, at a later stage if required, on whether the aim is for a public flotation or to remain the flotation of your shares on a stock exchange, independent, and to minimise tax liability on any or their sale to another organisation, or other ultimate sale of equity. such transactions. • Valuing your company’s shares – for tax planning and Inland Revenue negotiation.The accountant’s roleThe primary role of the accountant acting on behalf of Tax advicethe private equity firm, in an MBO transaction for The tax adviser will also help to ensure that, whereexample, is to undertake investigatory due diligence, possible:such as described on pages 37-38. The precise scope of • Tax relief is available for interest paid on personalthe accountant’s role varies from situation to situation borrowings to finance management’s equitybut typically includes: investment.• Reporting formally on projections. • Potential gains on the sale of equity are taxed as a• Undertaking financial and commercial due diligence capital gain and not treated as earned income. – often a prerequisite to private equity investment. • Capital gains tax (CGT) is deferred on the sale The accountant will also be able to make informal of equity. judgmental opinions on aspects of the plan to the 41
    • The role of professional advisers continued• Exposure to Inheritance Tax is minimised. gains realised on the disposal of shares in a VCT. As with the EIS, the minimum holding period is three years.• Tax indemnities provided by the company directors Some of the tax benefits of VCTs have been eroded by and shareholders to the private equity firm the removal of tax credits on dividends and the are reviewed. introduction of taper relief on CGT.• Tax relief on professional costs in connection with an If you require a chartered accountant or financial adviser MBO, flotation or other exit is maximised. with experience in the private equity field, see the• Corporate funding is structured to maximise tax relief. “Associate Members – Professional Advisers” section within the BVCA’s Directory of members.• Tax due diligence procedures are properly carried out.Your tax adviser can also explain the qualifying criteria The lawyer’s roleunder which personal investments can be made through Usually there are at least two sets of lawyers involved inthe Enterprise Investment Scheme and in Venture the private equity process; one representing theCapital Trusts. management team and one representing the privateUnder the EIS, individuals not previously connected with equity firm. Other parties, such as bankers and othera qualifying unlisted trading company (including shares private equity firms, if acting as a syndicate, will eachtraded on AIM) can make investments of up to £200,000 want their own lawyer involved.in any tax year and receive tax relief at 20% on new The private equity firm’s lawyersubscriptions for ordinary shares in the company, and The lawyer is mainly concerned with ensuring that therelief from CGT on disposal, provided the investment is private equity firm’s investment is adequately protectedheld for three years. from a legal standpoint. The lawyer will draw up the variousFor VCTs, which are quoted companies similar in concept investment agreements, usually including the following:to investment trusts, income tax relief is available at 40% • Shareholders’ or subscription agreementson new subscriptions by individuals for ordinary shares Documents detailing the terms of the investment,in the VCTs. The maximum amount qualifying for relief is including any continuing obligations of management£200,000 each tax year. In addition, no tax is payable on required by the private equity firm, the warranties and42
    • indemnities given by the existing shareholders, penalty firm and, together with your financial adviser, will help clauses and the definition of shareholder rights. you to negotiate acceptable terms. The team’s lawyer will also, in due course, negotiate the investment• Warranties and indemnities agreements with the private equity firm’s lawyer and Documents that confirm specific information produce the disclosure letter, as well as negotiating any provided by the directors and/or shareholders to the loan documents with the banker’s lawyer. private equity firm. If this information turns out later to be inaccurate, the private equity firm can claim In the case of a new company, your lawyer can against the providers of the information for any incorporate the company and draw up the Memorandum resulting loss incurred. and Articles of Association, which govern the constitution of the company, its permitted activities and the powers of• Loan stock or debenture agreements its shareholders and directors. Even in the case of an A statement of the terms under which these forms of existing company, a new Memorandum may be required finance are provided. and new Articles almost certainly will be needed to document the dividend and other rights attaching to the• Service contracts company’s shares following the private equity Documents that formalise the conditions of investment. If you need to find a lawyer experienced in employment of key members of the management team. these areas, refer to the “Associate Members – Professional Advisers” section of the BVCA’s Directory.• Disclosure letter Contains all the key information disclosed to the private equity firm on which the investment decision Professional costs has been based. It is essential that the directors do In many cases, the costs of all the professional advisers not omit anything that could have an impact on that will be borne by the company receiving the investment. decision. The disclosure letter serves to limit the The private equity firm will usually increase the funding warranties and indemnities. provided to allow for these costs, so you and your team should not be “out of pocket” as a result, although youThe management team’s lawyer may be left with a slightly smaller equity stake. However,The management team’s lawyer will review the Offer there are circumstances where this is not possible, due toLetter (Heads of Agreement) from the private equity 43
    • The role of professional advisers continuedcontravention of Company Law, or where it is agreedthat each party bears its own costs.Ensure that you agree the basis of costs before anywork commences. In particular, ensure that you havefirm agreement as to who is to bear the costs in theevent of the negotiations being aborted. Usually in thiscase the private equity firm will bear the cost of workcommissioned by them and you will pay the costs ofyour own professional advisers.Professional costs incurred by the financial advisors,accountants and lawyers employed by the managementteam and the private equity firm, like any service, needto be carefully controlled. There is a range of costs thatwill depend on the complexity of the transaction, butwill typically be around 5% of the money being raised.44
    • Your relationship with your investorPrivate equity for growth and success matters, for management recruitment purposes as well as with their contacts and market information.Private equity investment has been demonstrated tocontribute significantly to companies’ growth. Private Most private equity firms’ executives have a wide rangeequity backed companies outperform leading UK of experience. Many have worked in industry andbusinesses. others have a financial background, but what is more important, all have the specialist experience of fundingThe annual “Economic Impact of Private Equity in the and assisting companies at a time of rapid developmentUK” shows that the vast majority of companies receiving and growth. Levels of support vary, however, rangingprivate equity believe that without private equity they from “hands-on” to “hands-off”.would not exist at all or would have developed lessrapidly. Furthermore the report consistently demonstratesthat private equity-backed companies increase their Hands-onsales, exports, investments and people employed at a A “hands-on” or active approach aims to add value toconsiderably higher rate that the national average. your company. In addition to advising on strategy and development, the private equity firm will have manyWhile the growth and success of these companies owes useful business connections to share with you. Themuch to private equity investment, enabling them to private equity firm aims to be your business partner,achieve their full potential, the non-financial input by the someone you can approach for helpful ideas andprivate equity firm is also a very important contributor. discussion. A hands-on investor is particularly suited to aThe private equity firm’s involvement generally does not company embarking on a period of rapid expansion.end following the initial investment. Of the private However, day-to-day operational control is rarelyequity backed companies analysed in this survey, sought. In order to provide this support, some privateannually over three-quarters say that their private equity equity firms will expect to participate through a seat onfirms make a major contribution other than the provision your board. The director may be an executive from theof money. Contributions cited by private equity-backed private equity firm or an external consultant and fees willcompanies often include private equity firms being usedto provide financial advice, guidance on strategic 45
    • Your relationship with your investor continuedneed to be paid for the director’s services. The private In realityequity firm will expect to: Most private equity firms in reality tend to operate somewhere between these two extremes.• Receive copies of your management accounts, promptly after each month end. Help to avoid the pitfalls• Receive copies of the minutes of the board of One of the private equity firm’s positive contributions to directors’ meetings. your business might be to help you avoid receivership or liquidation. They can help you spot the danger signs• Be consulted and involved in, and sometimes have of troubled times ahead and avoid business pitfalls. the right to veto, any important decisions affecting the company’s business. This will include major Examples of danger signs capital purchases, changes in strategic direction, • Lack of response to changing environments business acquisitions and disposals, appointment of directors and auditors, obtaining additional • Fixed price contracts borrowings, etc. • Increasing level of fixed costsHands-off • Cash flow problemsSome investors will have a less active role in the • Breaches in bank covenantsbusiness, a “hands-off” or passive approach, essentially • Failing to meet capital interest or dividend paymentsleaving management to run the business withoutinvolvement from the private equity firm, until it is time • Increasing overseas competitionto exit. They will still expect to receive regular financial • Over-tradinginformation. If your company defaults on payments,does not meet agreed targets or runs into other types of • Deteriorating credit controldifficulties, a typically hands-off investor is likely tobecome more closely involved with the management of • Uncontrolled capital expansionthe company to ensure its prospects are turned around. • Inaccurate and/or untimely management information46
    • • Autocratic management You should also have recourse to the new Combined Code on Corporate Governance which is aimed at enhancing• Financial impropriety board effectiveness and improving investor confidence• Early success, but no staying power by raising standards of corporate governance.• Over expansion and loss of control Guidelines for success• High turnover of key employees The following guidelines apply to most successful• Extravagant executive lifestyle business situations:• Dependence on too few customers/suppliers • Stick to what you know – avoid industries in which you are not experienced.Directors’ responsibilities • Encourage a common philosophy of shared businessAs a company director you have onerous responsibilities goals and quality standards so that you meet andto your shareholders and your creditors. Many of the even exceed the expectations of your customers.duties and obligations of a director are mandated by the Communicate the objectives and results throughoutCompanies Act 1985. Others are governed by the your organisation.Insolvency Act 1986 (you should be particularly aware of • Avoid information overload – concentrate yourthe “wrongful trading” provisions contained therein) and management information systems on what is criticalthe Company Directors’ Disqualification Act 1986. Under to success.the wrongful trading provisions a director may, by courtorder, be made personally liable for a company’s debts if • Build your team – as your business grows, recogniseit is allowed to continue trading at a time when it was the need to direct the company and to not beknown, or should have been concluded, to be insolvent. personally involved in each day-to-day decision,Discuss any concerns with your private equity firm and which should be delegated to senior managers.other professional advisers before they become real • Cash flow – remember “cash is king”, take care toproblems and help to ensure success for you, your manage your cash resources with the utmost care.management team and your investors. 47
    • Your relationship with your investor continued• Anticipate problems – know what is going to be critical as your company moves through its various growth stages.• Keep your investors, bankers and advisers informed – they are there to help and do not like surprises.• Watch your costs – ensure that the market price of your products gives a profit contribution in excess of the costs you incur. This may sound facile, but it is amazing how often this is not assessed regularly, resulting in unexpected losses.• Do not anticipate sales – the costs can grow by themselves, but the sales will not.• Use the network – a well-developed set of business contacts is one of the keys to business success. These could include customers, suppliers, trade associations, Government agencies and professional advisers.• Look for opportunities – the business plan is the agreed route forward for the business, but other opportunities will arise. Assess them, discuss them with your investors and pursue them if it makes sense for the business. Adapt your business plan as your company develops and new opportunities are considered.48
    • Realising the investmentMany business owners and shareholder management Repurchaseteams are looking at some point to sell their investment The repurchase of the private equity investors’ sharesor seek a stock market listing in order to realise a capital by the company and/or its management.gain. Private equity firms usually also require an exit To repurchase shares you and your advisers will need toroute in order to realise a return on their investments. consult the Companies Act, which governs theThe time frame from investment to exit can be as little as conditions of this exit option. Advance clearance fromtwo years or as much as ten or more years. At the time the Inland Revenue and professional accounting and taxof exit, the private equity firm may not sell all the shares advice is essential before choosing this route.it holds. In the case of a flotation, private equity firmsare likely to continue to hold the newly quoted shares Refinancingfor a year or more. The purchase of the private equity investors’ or others’ shareholdings by another investment institution.The options This type of exit may be most suitable for a companyThe five main exit options are listed below. If you are that is not yet willing or ready for flotation or trade sale,considering any of these, you will need the specialist but whose private equity investors may need an exit.advice of experienced professional advisers. FlotationTrade sale To obtain a quotation or IPO on a stock exchange, suchThe sale of your company’s shares to another company, as the Official List of the London Stock Exchange, AIMperhaps in the same industry sector. or NASDAQ (USA).The majority of exits are achieved through a trade sale. A stock market quotation has various advantages andThis often brings a higher valuation to the company disadvantages for the entrepreneur (see box over).being sold than a full stock market quotation, becausethe acquirer actually needs the company to supplement Involuntary exitits own business area, unlike a public shareholder. Where the company goes into receivership or liquidation. 49
    • Realising the investment continuedGoing public Valuing the investment on exitAdvantages For partial disposals and certain exits it is often• Realisation of some or all of the owner’s capital necessary to arrive at a mutually acceptable valuation of• Finance available for expansion the company. The BVCA has produced guidelines that address the bases and methodologies to be used for• Marketable shares available for acquisitions valuing private equity investments although these are aimed principally at private equity fund managers, to• Enhanced status and public awareness provide consistency and commonality of valuation• Increased employee motivation via share incentive standards amongst funds, largely for fund performance schemes measurement purposes. For guidance on valuing your company prior to initial private equity investment, seeDisadvantages page 31.• Possible loss of control• Requirement to reveal all price sensitive information which may also be of interest to your competitors• Unwelcome bids• Continuing obligations – costs and management time incurred• Increased scrutiny from shareholders and media• Perceived emphasis on short-term profits and dividend performance• The cost50
    • Before you do anything – read this!Legal and regulatory issues you must comply business, communicate an invitation or inducement towith in raising finance engage in investment activity". This does not apply if the person is an authorised person under the FSMA or theRaising finance is a complex legal and regulatory area contents of the communication are approved by anand you should be aware of the need to take legal authorised person. As you are likely to be raising financeadvice during the process. In particular, sending a to start-up or to expand your business it is unlikely thatbusiness plan to, or discussing it with, potential you will be authorised. However, the FSMA (Financialinvestors, is a financial promotion and this may require Promotion) Order 2001 (Financial Promotion Order) setsyou or other persons involved in the process to be out various other main exemptions to the FSMA andauthorised or regulated here in the UK. In some cases, if these need to be carefully considered in each case.you are not authorised by the Financial Services Authority,you may be committing a criminal offence or agreements The Financial Promotion Order differentiates betweenentered into may not be enforceable against the other real-time and non real-time communications. A real-timeparties. Whilst financial promotions sent by those communication is one that is a communication made inseeking funds to private equity houses will, in most the course of a personal visit, telephone conversation orcases, be exempt from restrictions in the Financial other interactive dialogue. A non real-time communicationServices and Markets Act (FSMA), you should read the is one that does not fall within the definition of a real-notes below for a summary of the various exemptions to time communication and includes letters, emails andthe FSMA and the cautions on the inclusion of publications (including TV and teletext). The Financialmisleading statements in your financial promotion. We Promotion Order also sets out indicators to look forrecommend that you seek professional/legal advice when determining if a communication is a non real-timebefore communicating your plans to anyone. communication. The indicators include if the communicationThis section of the Guide is not intended to give is directed to more than one recipient in identical termslegal advice nor substitute for you taking your own or if the communication is made in a way that theprofessional and/or legal advice in these areas. recipient cannot or is not required to reply immediately or can refer to it at a later time.The Financial Services and Markets Act (“FSMA”) The Financial Promotion Order also distinguishesThe FSMA came into force on 1 December 2001 and between solicited and unsolicited real-time calls, solicitedprovides that "a person must not, in the course of calls being ones which are initiated by the recipient or 51
    • Before you do anything – read this! continuedtake place following an express request (which is more large companies which have a corporate treasurythan mere acquiescence) from the recipient. function, other persons who carry on activities but are excluded by the Regulated Activities Order).Relevant exemptions to individuals or companiescommunicating business plans to potential investors Also exempted are persons acting in their capacity asinclude the following. Please note that, at the time of directors, officers or employees of such entities such aswriting, the exemptions relating to the sale of body directors, officers or employees of authorised privatecorporates and takeovers are under review. You are equity and venture capital firms.recommended to take legal advice before applying anyof the exemptions outlined below. One-off communications There are exemptions for one-off non real-timeInvestment professionals communications and solicited real-time communicationsThis exemption applies to financial promotions made in relation to certain categories of investments such asonly to or directed only at the following types of person buying, selling or subscribing for securities and advisingwho are sophisticated enough to understand the risks on investments. Subject to certain exceptions forinvolved. These are: solicited real-time communications, to benefit from this exemption, the communication must be made only to• Authorised persons one recipient (or group who are expected to act jointly),• Governments and local authorities it must identify the product or service and not be part of an organised marketing campaign.• Professional firms who are exempt under the Act High net worth individuals• Exempt persons (where the financial promotion High net worth individuals can sign a certificate relates to a controlled activity which is a regulated exempting them from the general financial promotion activity for which a person is exempt). restrictions of the FSMA in relation to certain categories• Persons whose ordinary business involves carrying of investments such as buying, selling or subscribing for on a controlled activity of the kind to which the securities or receiving advice on investments and in financial promotion relates (i.e. private equity and relation to non real-time communications or solicited venture capital firms, investment trust companies, real-time communications. To benefit from this52
    • exemption they must, inter alia, have an annual income procedures are in place to prevent others acting upon it.of not less than £100,000 or net assets to the value of The distinction between real-time and non real-timenot less than £250,000, both as certified by their communications is not made for this exemption, nor isemployer or an accountant. To fall within the exemption, there a requirement for a certificate as in the case of thethe communication must be made to that individual and exemption for high net worth individuals. Instead, themust relate to certain categories of investments that can person making the communication must have ainclude unquoted securities. It should be noted that, to reasonable belief that the recipients are high net worthbe used, a certificate must have been provided before companies, etc.the relevant communication is made. Sophisticated investorsHigh net worth companies "Sophisticated investors" can sign a certificate exemptingSubject to certain conditions, the financial promotion them from the general restrictions on financialrestriction does not apply to communications in relation promotion in relation to certain categories ofto certain categories of investments such as buying, investments such as buying, selling or subscribing forselling or subscribing for securities and advising on securities and receiving advice on investments, if theyinvestments which are made only to a body corporate can produce a statement from an authorised personwhich has net assets or called up share capital of stating, inter alia, that that person is sophisticated£500,000 (if the company has more than 20 members) enough to understand the risks involved in that type ofor £5,000,000 for other companies, a partnership or investment. It should again be noted that, to be used, aunincorporated association which has net assets of not certificate must have been provided before theless than £5,000,000, the trustees of a high value trust communication is made. Any communication to a(assets of £10,000,000 or more) or to any director or sophisticated investor must also be accompanied byofficer of the high net worth company whose certain "health warnings" to qualify for this exemption.responsibilities include engaging in investment activity. This exemption is not limited to non real-time orThe conditions are that the communication must solicited real-time communications. As there is nodescribe the person to whom it is directed and state that financial qualification (in contrast to the high net worthit relates to controlled investments or activities, the individuals exemption) it is likely to be more useful incommunication must carry a health warning advising marketing securities to private clients.others not to act on it and provide that suitable 53
    • Before you do anything – read this! continuedAssociations of high net worth or sophisticated investors which relates to the acquisition of day to day control of aThere is also an exemption in relation to certain body corporate, is exempt from the financial promotioncategories of investments such as buying, selling or restriction. There is also an exemption for takeovers,subscribing for securities and advising on investments although this is subject to further conditions andfor non real-time communications or solicited real-time requires further information to be provided.communications, which are made to associations of There are also other exemptions available which mayhigh net worth or sophisticated investors. This not be relevant in the case of private equity financing.exemption is limited to situations where the investmentis of a type which means that the person does not incura liability to contribute more than he commits by way of Misleading statementsinvestment, for example, a regular contribution to a The FSMA generally prohibits the inclusion of misleadingbusiness angel network. statements in documents that are designed to induce or persuade people to enter into investment agreements orCommon interest groups of a company to buy or sell shares in companies. This would thereforeA non real-time communication or solicited real-time apply to your business plan. Any person who makes acommunication in relation to investments in a company, statement, promise or forecast or dishonestly concealssuch as shares and debentures, which is made to a any material facts, or who recklessly makes (dishonestlygroup of persons with an existing common interest with or otherwise) a statement, promise or forecast which iseach other and that company may be exempt. Again to misleading, false or deceptive, is guilty of an offence if hebe exempt the communication must be accompanied by makes the statement, etc. for the purpose of inducing (orcertain "health warnings". is reckless as to whether it will induce) another person to enter or offer to enter into an investment agreement.Sale of a body corporate Sanctions for a contravention of these provisions includesA communication made in relation to an acquisition or imprisonment up to seven years or a fine or both.disposal of shares in a body corporate which satisfiescertain conditions, such as that it relates to or will result It is therefore essential that, irrespective of whether orin the sale of 50 per cent or more of the voting rights in not any of the exemptions in relation to financiala company to another body corporate, partnership, promotions apply, any statement, promise or forecastsingle individual or group of connected individuals, or contained in any communication, document, including a54
    • business plan, private placement memorandum,information memorandum, etc., made available topotential investors is verified in order to ascertainwhether by itself, or taken in the context in which itappears, it could possibly be misleading or false ordeceptive. This verification could be carried out by anauthorised person such as an investment bank,corporate finance boutique or authorised professionalservices firm. If however you are sending your plan to aUK private equity house which is itself authorised thenyou do not have to have this verification processundertaken. You should nevertheless ensure that theplan does not contain misleading statements.In case of any doubt, if you are seeking equity or debtfinance, other than ordinary banking facilities, you arerecommended to obtain legal advice before making anycommunications (whether written or oral) with potentialinvestors, including the circulation of your business plan. 55
    • Appendix – further information • Providing a forum for the exchange of views among members.Contact details: • Acting as a source of education and training forBVCA employees of member companies.3 Clements InnLondon WC2A 2AZ • Developing and encouraging the highest standards of professional practice.Tel: +44 (0)20-7025 2950Fax: +44 (0)20-7025 2951 • Liaising with fund providers and political, regulatory and media contacts.Email: bvca@bvca.co.ukWebsite: www.bvca.co.uk BVCA publications and researchThe BVCA represents private equity and venture capital Directory of Membersin the UK and is devoted to promoting the private Lists private equity firms and their contact details,equity industry and improving the performance and identifies their investment preferences (i.e. theprofessional standards of member firms and the minimum and maximum amounts, financing stage,individuals within those firms. Its members include industry sector and location). Also provides details ofprivate equity firms, professional advisers, corporate associate members including professional and otherfinanciers, mezzanine firms and other companies whose advisers, who are active in the private equity field.executives are experienced in the private equity field. Published annually.The BVCA’s primary objective is to increase awarenessand general perception of private equity by: Directory of Members CD-ROM The CD-ROM contains a PDF version of the Directory of• Providing information about members to those Members. Published annually. seeking private equity. Entrepreneurs• Representing members’ views and interests in A file containing case studies of private equity backed discussions with Government and other organisations. entrepreneurs.56
    • Report on Investment Activity Limited Partnership AgreementAnalysis of private equity industry investment, by The Limited Partnership Agreement is the key legalfinancing stage, industry sector, region and type of document used for private equity funds formed asprivate equity company, with details on independent limited partnerships. These explanatory notes arefunds raised. Collated by PricewaterhouseCoopers. designed to explain the provisions commonly found inPublished annually in May/June. this documentation. Published in November 2002.The Economic Impact of Private Equity in the UK A Guide to Investing in EuropeThe major survey of private equity and venture backed Produced jointly by the BVCA and Ashurst Morris Crisp,companies analysing their growth and contribution to this publication assists private equity practitioners whenthe national economy, measured in terms of job investing in Europe. Topics covered include capitalcreation, sales revenues and exports against FTSE 100 structure, board and employee matters as well as issuesand FTSE Mid-250 companies and national growth of common concern. Published April 2002.rates. Published annually in November. A Guide to Term SheetsPerformance Measurement Survey A guide aimed to provide those not familiar with theAn annual report analysing the aggregate net returns to venture capital investment process with an outline of howinvestors from independent private equity funds by year investments can be structured. Produced May 2004.and type of fund. Produced by PricewaterhouseCoopers For a complete list of BVCA publications and details onfor the BVCA. Published annually in May/June. ordering, please visit the BVCA website www.bvca.co.uk.Reporting and Valuation GuidelinesReporting Guidelines, addressing the content,frequency and timing of reports to private equityinvestors, and Valuation Guidelines, addressing thebasis and methodologies to be used for valuing privateequity investments. Published in July 2003. 57
    • Other useful contactsBusiness Link0845-600 9006 or www.businesslink.orgThe equivalent bodies to Business Link are BusinessConnect in Wales, Small Business Gateways in lowlandScotland, Business Information Sources in theHighlands, and EDnet in Northern Ireland.Enterprise Investment Scheme (EIS) Association01732-465828 or www.eisa.org.ukAlso see the BVCA Directory under “ProfessionalAdvisers” for details on chartered accountants andlawyers with experience in the private equity field,who are associate members of the BVCA.58
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    • 3 Clements Inn PricewaterhouseCoopers LLPLondon 1 Embankment Place, LondonWC2A 2AZ WC2N 6RHT 020-7025 2950 T 020-7583 5000F 020-7025 2951 F 020-7822 4652E bvca@bvca.co.uk W www.pwc.com/ukW www.bvca.co.uk This Guide was written for the BVCA by Keith Arundale,Founded in 1983, the BVCA represents private equity and Director at PricewaterhouseCoopers LLP.venture capital in the UK. We are devoted to promoting PricewaterhouseCoopers (www.pwc.com/uk) providesthe private equity industry and improving the industry-focused assurance, tax and advisory services forperformance and professional standards of member firms public and private clients. More than 120,000 people inand the individual within those firms. 139 countries connect their thinking, experience and solutions to build public trust and enhance value forDisclaimer clients and their stakeholders.This Guide has been prepared for general guidance on “PricewaterhouseCoopers” refers to PricewaterhouseCoopersmatters of interest only, and does not constitute professional LLP (a limited liability partnership in the United Kingdom)advice. You should not act upon the information contained or, as the context requires, other member firms ofin this document without obtaining specific professional PricewaterhouseCoopers International Limited, each ofadvice. Accordingly, to the extent permitted by law, the which is a separate and independent legal entity.BVCA, PricewaterhouseCoopers, their members,employees and agents accept no liability, and disclaim all (www.driving-ambition.com)responsibility, for the consequences of you or anyone else illustrates the issues and opportunities surrounding anacting, or refraining to act, in reliance on the information ambitious business in its development and directs businesscontained in this document or for any decision based on it. owners and management teams to the appropriate services available from PricewaterhouseCoopers.BVCA and PricewaterhouseCoopers© 2004. All rights reserved. Our corporate finance specialists work with management teams from many industry sectors through all the stages of the private equity life cycle (www.pwc.com/cf/privateequity). PricewaterhouseCoopers also provides corporate finance, due diligence, audit and tax services to private equity houses and their investee companies.