Survey Shows Midmarket Firms Want Owner Skin in the Game
June 09, 2015
(c) 2015 Dow Jones & Company, Inc.
Owners of many midmarket companies looking to sell the majority of their businesses to private equity firms should be prepared to reinvest a portion of the equity they own back into the company, according to a recent survey conducted by law firm Goodwin Procter LLP .
Among the more than 60 firms surveyed, 70.7% said they require owners of the companies in which they purchase majority stakes to reinvest at least some of their equity back into the newly recapitalized company, in what is typically referred to as an equity rollover.
Equity rollovers have become increasingly common in private equity deals as a way of aligning the interests of founders and management with their private equity owners, particularly if the owners and managers plan to continue running the company. The use of equity rollovers can also help private equity buyers increase their bidding power in a high pricing environment by offsetting the higher purchase price with equity that a seller agrees to reinvest back into the company.
According to the survey, deals involving equity investments ranging from just over $100 million to $500 million had the highest minimum equity roller requirement, with an average of 20.1% of an owner's equity holdings before the transaction, while deals with more than $500 million in equity carried an average minimum rollover of just 14%.
That said, the overall average rollover in transactions by all of the survey respondents hit a much higher 24.1% of the seller's total equity holdings before the transaction. The average actual rollover percentage was highest-at 28.5%-for smaller deals in which the total equity investment was $100 million or less.
The survey also measured the percentage of equity in a deal that midmarket firms set aside as incentive to retain management teams and motivate them to drive company performance. Firms surveyed allocated an average of 11.3% of the fully diluted equity capitalization of a deal for management incentive pools, although the average percentage of equity set aside for management incentive pools was highest among the smaller deals.
Management teams appear to have considerable influence over the size and structure of these management incentive allocations. More than half of the firms surveyed said management usually succeeds in negotiating a larger incentive equity pool than the firm initially proposes, and another 12.3% said management always succeeds in doing so.
"In a large number of deals these days, management are tuned into the fact that they can negotiate this," said John Greenland, a partner in the New York office of Jamieson Corporate Finance, which focuses on advising management teams in buyout deals.
Mr. Greenland added that the growing popularity of secondary buyouts, in which one private equity firm sells to another, may also encourage management teams to flex their negotiating muscles.
"When you have a sponsor-to-sponsor transaction, the management has skin in the game already, so they're more conscious of the art of the possible when it comes to incentive," he said.