Management Teams Demand Better Terms

Yolanda Bobeldijk and Becky Pritchard

Finanical News 16 Nov 2015

Management teams of U.K. companies are attempting to get better pay packets when they are acquired, as buyout firms compete to woo sellers in a highly competitive market, according to lawyers and advisers.

The fiercely competitive nature of today’s deal environment, in which private equity money is competing with cash-rich trade buyers for deal opportunities, is helping management teams negotiate better deals, advisers said.

Paul Dolman, head of private equity at Travers Smith, said: “There is a lot of competition for the best assets. Given that there are generally three variables to winning an auction: price, deal deliverability and management preference, where the race is tight, management may ultimately have the whip hand on which buyer will win the deal.”

The advisory community has become more professionalised, Stephen Drewitt, a partner at law firm Macfarlanes added, meaning that in most cases management teams are well-represented at the negotiating table. “If you were to track back to ‘06, often the management advice was only an add-on to someone else’s role.”

Management teams have been getting more generous sweet equity deals – shares in the company that are designed to give management an added incentive to increase profitability when a buyout firm exits a company.

They have also benefitted from changes to ratchets, where the management team gets a bigger slice of the profits if a company makes an exceptionally high return when a buyout firm exits a portfolio company. Management teams are also pushing for terms that allow them to cash out more of their investment in a company if it gets sold by one private equity firm to another.

Leaver provisions – terms that apply when management leaves the company before the private equity house sells – are also improving.

Simon Cope-Thompson, a partner at M&A adviser Livingstone Partners, said: “Another trend is that the sweet equity is structured in a way that management gets to keep the sweet equity when they leave.” He explained that a private equity house could not revoke management teams’ stakes, even when they decided to leave early in an investment.

What’s more, as market conditions have improved, management teams are focusing less on protection for themselves if a deal goes wrong and more on getting a bigger slice of the cake, according to David Allen, a partner at Baker & McKenzie.

He said: “When the financial crisis happened, you saw a number of portfolio companies going bust and management teams losing all of their equity. There was significant focus on downside protection as a result. Slowly but surely, some of those concerns became less front of mind.”

Buyout firms typically structure a large portion of their equity investment as a shareholder note, which charges the portfolio company interest. Before the management team can get their share of the profits of an exit, that interest needs to be repaid. Some management teams have sought to lower the interest rate, which was on average typically around 15% five years ago and is now about 10%. That means management teams will see their profits sooner, advisers say.

“Management teams are much more focused on being aligned with investors to share in the value creation earlier on,” said Stuart Coventry, a partner at Jamieson Corporate Finance.

Such terms are also discussed earlier in the bidding process compared to a few years ago, said Mr. Cope-Thompson. “We often try to get a term sheet [to discuss the management terms] in the second round. There’s certainly more understanding that this is important.”