Debt Q&A

Neil McDaid, Director Corporate Finance, BDO Stoy Hayward
09 March 2009

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For months the markets have focused on the negative aspects of the credit crunch. But alas there is a silver lining - deal sourcing should be improved, allowing private equity firms to secure attractive entry multiples. unquote" editor-in-chief Kimberly Romaine chats to Neil McDaid, a debt advisory director at BDO Stoy Hayward about the latest trends

KR: Debt is scarce and vendors are loathe to bring down their prices. What trends are you seeing at the moment regarding deal funding?

NM: There are a couple of trends that we've seen in the past but are becoming more prevalent nowadays. One is a private equity sponsor underwriting the debt for a deal, with a view to refinancing within six months. This way they get a fee for the underwriting, but then when they get their funds back they can re-invest them elsewhere.

The other trend we're seeing is on the side of the vendor. To make deals work in today's environment, they are looking at other ways of being compensated for their businesses, namely by being willing to defer payment. For example we are seeing more vendor roll over and earn outs. They are performance-based and can allow a vendor to get up to an extra turn of equity to be paid out over a couple of years instead of locking in a potentially lesser valuation at the onset.

KR: So 'buy-now, pay later' might help things. What about sentiment of the vendors that are indeed out there, or business owners looking to sell?

NM: It is difficult to find very strong businesses for sale these days, because most owners are hanging on to them, hoping to achieve higher multiples in the future. It is mostly just distressed sellers out there at the moment. As a result there is a real dislocation between buyers' and sellers' price expectations. The aforementioned vendor rollovers and earn outs are a way to help bridge that.

Another driver of sales - which will force down prices for private equity backed companies - will be fund managers that are over-long on their portfolios. Many will face pressure from their limited partners to return money later this year and next, so the GPs will have to push pressure down the line on their business owners. This should result in a meeting of price expectations and should drive dealflow later this year and next.

KR: Half the reason the market has come to a standstill is a lack of leverage; the other half is vendor price expectations. Where can private equity firms look for dealflow in today's market?

NM: A major source has always been and will continue to be large corporates with non-core assets. Now more than ever they may be willing to offload these.

In particular I'd suggest buyout houses look for those pursuing refinancings in the next 18-24 months, and some may be putting in place forward-start facilities now. Because there will be fewer banks to lend, those looking to refinance soon will likely get less debt, so corporates will only pursue forward starts if they feel they will have less need for leverage.

Another source of deals many are talking about are the public to private transactions. Valuations are attractive and fund managers are receptive to takeover offers. We have recently completed a survey of quoted companies (with a market cap up to £250m) and a very significant proportion of fund managers and CEOs said the capital markets didn't work for companies with a market cap below £100m and that private equity was better at supporting growth and bolt on acquisitions.

Finally, banks may prove sellers of equity acquired through restructuring and debt for equity swaps. The banks are not set up to manage these unplanned equity investments and in due course they will need to sell these businesses or bring in operating partners to assist them.