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Beyond capital: winning over Germany's Mittelstand vendors

Burkhard von Wangenheim of Afinum
Burkhard von Wangenheim, Afinum
  • Katharina Semke
  • Katharina Semke
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Investors in Germany need to differentiate themselves beyond the bidding price in an environment of stagnating dealflow and an ever larger number of players. Katharina Semke looks at the strategies deployed by local private equity players

"Capital itself has long ceased to be a distinguishing factor in private equity," says Burkhard von Wangenheim (pictured above), an investment director at private equity firm Afinum. He highlights the need for private equity firms to remain flexible and adjust their investment model in order to convince entrepreneurs and family owners to sell their business. "Depending on the situation, we do all-equity and leveraged structures, majority and minority positions, buyout and growth capital investments. In the context of a number of growth investments, we have also offered repurchase options or upside kickers for the incumbent shareholders."

Since the start of 2016, Germany has seen 37 buyouts, peaking in May with seven and seeing lows of three deals in February and June, according to unquote" data. In comparison, the UK has been home to 88 buyouts since the start of the year, with as many as 19 in April.

We sometimes offer reinvesting vendors an additional upside or a buy-back option. Those are instruments to differentiate from competitors" – Burkhard von Wangenheim, Afinum

So far, there have been 16 buyouts from family and private owners in Germany in 2016. This includes Equistone's acquisition of candle manufacturer Gala in February – the sale was set up to facilitate the company's succession when its founder and managing director retired. Buyouts from these types of vendors have been relatively stable in recent years, with 24 and 21 in 2013 and 2014 respectively, and were slightly higher in 2015, with 29 recorded by unquote" data.

Bridgepoint chairman Uwe Kolb also believes an adaptation of the private equity model is required in the region to unlock more dealflow. This includes a partnership with selling family owners and entrepreneurs, requiring private equity firms to be mindful of their demands and show flexibility: "Often they are reluctant to sell the whole business and want a staged exit. Instead, they reinvest part of the proceeds and thereby remain a minority shareholder."

Capital structure and minority investing
One way to stand out in negotiations could be to show flexibility when it comes to the capital structure. A guarantee from the investor that it will not over-leverage a business is the first and most obvious step to take. Kolb says the idea of leverage is often new for business owners: "These companies are often completely self-financed. Private equity firms have to explain that they need to apply an efficient capital structure," he says, arguing that in order to remain competitive, private equity firms have to consider compromising with a family owner and implementing a capital structure that allays fears.

Other firms go even further and refrain from debt altogether. During its negotiations for one portfolio company this year, Afinum had to promise in its letter of intent that it would not leverage the business at all over the following three years. However, there are tools beyond leverage to win over potential vendors. "We sometimes offer reinvesting vendors an additional upside or a buy-back option. Those are instruments to differentiate from competitors," says von Wangenheim.

Majority control is another private equity staple that buyout houses should consider revisiting for the right deal – even though it may not always be an ideal scenario for a GP. "I have no problem with minority investments," says Nick Money-Kyrle, founding partner of Steadfast Capital. "The only point to be aware of is that it is not as easy to trigger a liquidity situation." This can be an issue for private equity firms, which have to exit after a certain number of years and therefore need a clear understanding of the timing and terms of their exit.

Another pitfall that makes this strategy a tricky one to execute is the potential decision-making penalty, according to Money-Kyrle: "You have to be sure you are properly represented in all the decision-making processes and can't be watered down by a majority investor, for example when they decide to do a share capital increase."

GPs must ensure they have a right to their say and that all shareholders have a clear understanding of their exit time plan. Once these issues are settled, minority investments could be a way for private equity firms to get in on deals they would otherwise have missed out on. Carlyle, for example, acquired a minority stake in German clinic chain Schön Klinik in July this year, while Afinum bought a minority stake in compatriot software company Empolis in November 2015.

Longer holding periods
Private equity firms often state their holding periods as a hindrance in negotiations. Earlier this year, Silver Investment Partners (SIP) secured a stake in aircraft supplier Schüschke. Talking to unquote", the exiting entrepreneur underlined his focus on safeguarding the production site, jobs and long-term continuity. The GP's bid prevailed because it accepted the vendor's terms, but also stood out because it works on a deal-by-deal basis, which allows it to remain invested in companies for a longer period than GPs with a traditional fund structure.

Private equity's holding periods can indeed be short compared to those of other investors. Money-Kyrle believes this is one of the most critical points for entrepreneurs when considering a private equity buyer as opposed to selling to a family office or an industrial holding: "They do not like the idea of companies being traded from one owner to another over a short time period, because the transfer of ownership can be very disruptive." In negotiations, Money-Kyrle is therefore keener on highlighting the companies Steadfast held for longer periods rather than those they have sold more quickly.

There is very little innovation in terms of private equity fund structures. This standardisation is a great shame and I think structures should be able to evolve to cater to differing investment strategies" – Nick Money-Kyrle, Steadfast Capital

However, despite adding a year or two to a holding period, there is not much private equity can do about the timeline of its ownership. Von Wangenheim says Afinum tries to paint a realistic picture for the vendor and is open about its time limit: "We plan for three to five years, but if the exit gets delayed by one or two years, it is no problem. What counts is the return we achieve for our investors."

Nevertheless, Money-Kyrle calls for more flexibility: "There is very little innovation in terms of private equity fund structures. This standardisation is a great shame and I think structures should be able to evolve to cater to differing investment strategies."

Workforce focus
When Quantum Capital Partners acquired train maintenance business Bahnwerk Eberswalde in July this year, it was the GP's promise to save 210 of 320 jobs and keep the site running for another five years that helped it win the turnaround deal. Not only in an unusual situation like this, but quite frequently throughout Germany, investors have to consider a family owner's feeling of responsibility and loyalty to the business and its staff. The future of their employees is an important issue for many entrepreneurs in the country, since it determines their future reputation and life in their community.

Money-Kyrle therefore addresses the topic in negotiations: "Many of these owners live very close to their businesses and they are often the largest employer in the area. It is very important for them to sell to a responsible buyer who ensures the company continues to thrive and that they can continue to live near their former business, meet their former employees and be happy that they have passed their life's work into the right hands." However, he admits that private equity firms have to manage expectations: they cannot absolutely guarantee to keep all employees during their ownership given how unpredictable events, such as a financial crisis, might affect the business.

The general dealflow in Germany has held steady at between 61 to 70 buyouts per annum since 2012, according to unquote" data. With GPs showing an increasing understanding of the German Mittelstand's focus on continuity and safety, this number might still rise in the years to come.

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