A flexible approach - Tailoring deal structures is crucial in todays market

07 April 2008

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Trying times require trying new methods of financing. Investec Growth & Acquisition Finance (Investec GAF) has just pumped GBP 6m into UK tour operator James Villa Holidays in a buyout that allows the management to hold a majority stake while simultaneously obtaining funding for future growth. This is despite a backdrop of growing economic uncertainty that has seen much of the leveraged buyout market grind to a halt.

"Obtaining senior debt has become more difficult, meaning asset-based lending, as well as other types of alternatives, are becoming more interesting," says Ed Cottrell at Investec GAF. The deal was unusual in that Investec GAF, acting as sponsor, took on a preferred equity role, with Bank of Scotland providing senior debt. Unlike traditional equity, it means that Investec GAF can protect its investment: significant equity rolled over by management and private investors means they sit below Investec GAF's, which is first ranking.

Management also benefit, since adding that layer to the capital structure makes the deal less dilutive than a traditional MBO, allowing management to retain a majority stake. "Our slice enabled management to leverage their position, while at the same time providing affordable finance," Cottrell explains.

Such innovative deal structuring has become increasingly important in today's market. In fact, rather than seeing its deal pipeline dry up, Cottrell maintains theirs is stronger than ever, indicating the team were due to close another similar deal within days of the James Villa Holidays transaction. This may be down to the chameleon-like ways Investec GAF has become known for. It pioneered its preferred equity strategy when it backed the £32m Isis-led buyout of DVC Sales (now known as Reach) in November 2004.

The innovative strip was repeated in August 2005, when Investec GAF participated in a £40m MBO of Superglass. The deals saw NBGI Private Equity act as lead sponsor, with Clydesdale Bank providing senior debt and Investec GAF supplying £4m of mezzanine. Post-completion Investec GAF offered a £2.5m preferred equity slice to NBGI, meaning the sponsor had an alternative to syndicating and therefore bypassed stake dilution. Less than two years later NBGI realised an IRR of 244% when the company was floated on the London Stock Exchange, corresponding to a money multiple of 10.7x. Without the preferred equity slice, this multiple would have been around 8.7x.

Other players in the small buyout space are also experimenting with new ways to do deals. Last summer, as the credit crunch began to take shape, Matrix Private Equity Partners provided £4.6m of debt and equity for the £6.5m MBO of DiGiCo, a digital mixing consoler maker for post-production businesses. As Matrix operates a number of venture capital trusts (VCTs), the firm is under pressure to deploy its capital within a certain timeframe.

The innovative structure - believed to be the first time a VCT did an integrated finance deal - proved that innovation could get deals done in an otherwise difficult market. Matrix went on to structure two more deals with its integrated approach last autumn: it backed the £6m MBO of Focus Pharmaceuticals, a Midlands generics business, and injected £3m into the MBO of water treatment business Monsal.