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The IBA’s response to the war in Ukraine
Sorainen, Tallinn, Estonia
BarensKrans, The Hague, the Netherlands
Cuatrecasas, Barcelona, Spain; Conference Quality Officer, Closely Held Companies Committee
Luther, Frankfurt, Germany; Chair, Closely Held Companies Committee
Morrison & Foerster, Miami, Florida, United States; Co-Chair, Lesbian, Gay, Bisexual, Transgender and Intersex (LGBTI) Law Committee
Fabiola Augusta Cavalcanti
Tozzini Freire Advogados, Rio de Janeiro, Brazil; Pro Bono Initiatives Officer, Latin American Regional Forum
Van Doorne, Amsterdam, the Netherlands
Shardul Amarchand Mangaldas & Co, New Delhi, Delhi, India
JP Morgan Chase & Co, London, England
Daniel Taylor began by providing an insight from the private bank perspective, stating that recent years had seen records in private equity, particularly capital raised. This also includes the highest level of dry powder globally, estimated to be in excess of US$3tn, and it has become increasingly straightforward to raise funds. Daniel explained that it may seem like a good thing to have dry powder, but it is aging (affected by increasing interest rates and inflation) and investors want to see their money invested. Consequently, the most difficult thing for fund managers is to put cash to work. Cash management is key. Among others, more fund managers may be forced to look for opportunities in closely held business.
Session Co-Chairs Alejandro Paya and Andreas Kloyer asked the panel about challenges that private equity investments bring to the business. Meltem Koning-Gungormez answered by explaining that businesses have become more complicated for family-owned concerns. Although in the Netherlands private equity investors have unfortunately been referred to as ‘grasshoppers’ or ‘barbarians’, they are increasingly looking out also for private equity investors, who are regarded as partners in navigating through the complexities. There is however, a tension between entrepreneurship and control.
Fabiola Cavalcanti added that family businesses often make a mistake by not undertaking due diligence when selecting an investor, who may not always be who they claim to be during the discussions stage. One way of conducting due diligence is, for example, to talk to companies in the investor’s portfolio. From her experience in Latin America, Fabiola advised that it is important to choose the partner. Randy Bullard seconded that the choice of the right partner is one of the most important decisions, but he still sees companies going with the first investor that calls, frequently leading to deals with arduous terms.
Gunjan Shah stated that the challenges of onboarding private equity investors in India can be divided into six categories, which relate to different cultures. One is the different timeframe of the private equity investor, which is shorter than that of families due to fund life leading for example, to not agreeing with the capex plan of the company due to planned exit. Gunjan further explained that the other categories include exit timing and valuation gap. Daniel Taylor added that the valuation gap is also one of the factors which slows down M&A activity for the subsequent 12–18 months. Gunjan pointed out the difference in the rosy picture of the owners versus the more critical approach of investors, the speed of decision making as a source of conflicts, differences in risk appetite, as well as handing over control to private equity investor. Randy Bullard elaborated that issues such as ESG, financial reporting, independent directors, rules regarding conflict of interests etc, are critical for private equity investors and may create tensions in family owned businesses.
The Co-Chairs asked the panel to move on to discuss potential benefits of having a private equity investor on board. Randy Bullard explained that private equity investors may bring a greater reputation to the business (the perception of take-off). It may also create access to vendors and buyers, cash, contract and financial management, efficiency metrics, access to capital and most importantly negotiations of financing arrangements.
Meltem Koning-Gungormez elaborated that in the Netherlands there is currently a labour shortage, so a private equity investor will manage human capital and help to improve the workforce. A private equity investor would also improve the business’s corporate governance. Fabiola Calcanti agreed that the same benefits also apply in Latin America and will reduce related party transactions. Gunjan Shah confirmed that is also the case in India and that private equity investors also help with add-on acquisitions, improve ESG compliance and generally preparing the company for IPO. Taylor added that the involvement of a private equity investor will be perceived as a seal of approval by the market.
Co-Chairs Andreas Kloyer and Alejandro Paya asked the panel to talk about the legal clauses in transaction documents which mitigate risks and extend benefits. They stated that the best way to tackle this is to identify the risks, try to mitigate them and, if that is not possible, to let the seller bear them. The next question related to current trends. Meltem Koning-Gungormez said that she sees lots of provisions regulating ESG topics in shareholder agreements. Randy Bullard elaborated that the ‘G’ (governance) part of the ESG should not be forgotten and, if addressed properly, will make the business and exit process much easier. Alejandro Paya mentioned that there are only metrics in the ‘E’ (environmental) part of ESG, and challenged that for a potential buyer, arguing that the EBIT (earnings before interest and taxes) remains more important than ESG. The panel agreed that the financial results continue to be the most important, but ESG compliance also affects valuation and non-compliance and can be a deal breaker. Other clauses were also discussed. These included investor friendly clauses, lock-ins, upside sharing, minority protection provisions, ESG and W&I (warranty and indemnity) coverage etc.
The Co-Chairs asked Daniel Taylor to speak about his recent experience with leveraging PE investments into family-owned or closely-held enterprises. Daniel explained that leveraging helps investors move more flexibly and quickly. Historically cheap loans are also a risk and it is important to look at sources to repay these loans.
In his final remarks, Randy Bullard recommended choosing a PE investor who fits your personality. Fabiola Cavalcanti seconded that carrying out due diligence on an investor is important and reminded delegates of the importance of not rushing the negotiations. Meltem Koning-Gungormez suggested using investors to upgrade governance. Gunjan Shah said that India has the optimal eco system for PE investments, currently has a strong economy, and plenty of new entrepreneurs who need capital and available dry powder with PE funds. Daniel Taylor expects that there will be increased PE activity among family-owned businesses.