View from the North

When unquote" visited Manchester recently to get an update on market sentiment from local players in the region, the tone was cautious but quietly optimistic. The regional markets, in volume and value terms, have held up well in the face of the credit crunch and crunch-induced corrections are seen, broadly, as a positive.

Sell-side steps up

Sell-side advisory became a much lamented process when liquidity was abundant and often failed to give an accurate picture of the true state of a business. This has changed, according to Ray Stenton at LDC. "People are now realistic with growth plans and the sell-side advisers have become more realistic about the numbers they put in the information memorandum (IM), so on day one the expectations for the business are more sensible." In the go-go days valuations were flimsy, based on overly-optimistic forecasts and driven by a belief that multiples in any particular sector would rise inexorably. "In the past many advisors put out poor quality IMs and didn't do enough work to understand the business they were selling. Buyers can't be pushed around any more. The vendor's advisor needs to work hard to get a deal away," says Jon Schofield at corporate finance house Dow Schofield Watts. Cheap debt resulted in a proliferation of auction processes and competition was such that buyers had no recourse to demand a more detailed IM. With deals undertaken within ever-shorter timeframes and sellers dictating the process, this also led to questionable vendor due diligence, according to Stenton. "Vendor due diligence became a regurgitation of the IM and people began not to trust what the vendor due diligence report said." These practices are a thing of the past. Sellers and their advisers now have more work to do convincing the buyer population of the attractions of the business and must make greater effort to ensure the figures are robust.

Although the north-west never saw the level of debt multiples seen in the south-east during the liquidity bubble, the credit crunch and the worsening state of the markets over the past few weeks has seen banks re-assess their processes and approach deals with greater caution. Darryl Cooke of Hill Dickinson comments that "there is a greater awareness of liquidity and senior people at some banks are now getting involved in where cash gets allocated." Mark Blower at Lloyds TSB Corporate Markets says that banks have "moved back to the old-fashioned method of holding debt on the books and having a greater awareness of their assets. Credit quality is paramount." Discussing the state of Lloyds' own portfolio Blower says that "there is some underperformance but we are not seeing a wholesale change in the quality of the loan book." With banks tightening up their processes and scaling back lending, asset-based lending has recently been touted as an alternative option for buyers unable to secure the level of financing they require on a traditional cash-flow basis. Blower, however, questions whether an asset-based structure is right for a business with a recession on the horizon. "Does asset-based lending work if the debtor book isn't growing? As soon as a business starts to contract, a debtor facility produces less cash and may have a material impact on the facilities available to the business at a time when it may most need them."

Non-exec considerations

With recessionary pressures creeping into businesses the role of a management team is going to become more important than ever. Some firms have been stepping up their recruitment of experienced non-executive directors to guide a company through difficulties and Stenton concedes that "there are some teams that haven't been through a recession and need additional support." Commenting on the quality of non-execs and the value they can add, Stenton says that "when you have a very good non-exec chairman you know you have a very good non-exec chairman." If a private equity firm is looking to introduce a non-exec, doing so before problems spiral out of control is crucial. However, a private equity firm will only know if there is a problem if the management team informs them and Jonathan Boyers at KPMG believes that "in some cases management teams may be worried (about the prospects for the business) but they are not communicating that worry to the private equity sponsors."

Shuffling deals

A slow-growth environment will have obvious repercussions for private equity firms. Although deal-doers insist that a downturn is the best time to make money, current vintages are comprised of deals transacted in a benign market, some with unsustainable levels of debt. These funds will record lower returns than has been the case in the past few years, affecting remuneration levels for partners and LPs. To offset poor overall fund performance, Boyers believes that some funds may move recent deals and those they consider to have significant value left in them into the next generation of funds. "One option is for firms to move deals from the current fund to the next fund so that the growth comes in for that fund," he says. If firms were to consider this they would have to tread carefully. There could be a temptation to migrate all the 'good' deals into the new fund, leave the 'bad' deals sitting in the current fund and wipe out any value you may have created by picking more selectively. LPs would certainly need convincing that this is the best route to take.

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