Private businesses are increasingly using debt finance to fund transactions with shareholders. Is this appropriate for you?

Sajjad Hassam Senior Manager, Deals, PwC United Kingdom 01/08/18

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Having grown their business successfully over a number of years, shareholders can often find that they have a sizeable proportion of their personal and family wealth tied up in one business. Often, shareholdings in a company can end-up split amongst founders and their “friends and family”, who may have helped support the entrepreneurs with startup capital. We are supporting an increasing number of established private businesses raise debt financing to fund shareholder transactions - buying out retiring founders, creating an avenue for minority shareholders to sell their equity or allowing entrepreneurs to release equity to invest in other ventures.

Releasing capital

Given how active debt markets are and currently low interest rates, we are finding that business owners are increasingly turning to debt-funded transactions that achieve shareholder objectives. In these transactions, the business incurs additional debt, releasing funds to “create a market” for equity.

For family businesses, the motivators of a shareholder transaction can be varied:

  • Buying back “friends and family” shareholders who contributed start-up capital
  • Creating a route by which founders can retire and realise value for their shareholdings
  • Releasing equity for shareholders to pursue other objectives, such as setting up an investment vehicle for other business projects

Assessment

The first step in assessing whether a debt deal is a suitable option is by undertaking a thorough assessment of how the business will be seen by potential lenders and assessing their appetite for lending. This typically involves getting “under the skin” of the business, understanding unique strengths as well as areas lenders will scrutinise further.

Alongside the high-street banks, challenger banks and direct-lending funds have created a highly competitive lending market, and therefore most businesses will want to explore a number of options to secure the best funding terms. Breadth of choice can allow management teams to choose between different repayment profiles, covenant packages and overall pricing for the debt package.

In our experience, the ideal candidate businesses are those that have a defensible market presence in a growing or stable sector, have a diverse management team and can readily display a track-record of generating cash.  We often spend time supporting clients evaluate their view of “sustainable” debt-capacity, considering how the business would perform under various trading scenarios and how affordable a particular quantum or structure of debt would be.

Once the sustainable “debt-capacity” of the business is understood, identifying the pricing and mechanics of a transaction (and any associated tax that would need to be paid) is absolutely key. Depending on the sector of the business, understanding any special regulatory approvals or other key steps before a deal can be completed should be identified early.

Future exit

A debt-raise process can be a useful “warm-up” to a transaction where the shareholding is marketed to external parties. These “third-party” transactions realise greater value for shareholders but are typically longer and more involved processes. As part of a debt-raising process, finance and commercial teams are exposed to the workings and scrutiny of a diligence exercise. Similarly, senior management would have to articulate the business proposition and strategy with clarity, answering questions from prospective lenders that will be similar to those posed by potential future buyers.

The teams at banks that look at shareholder-transactions are often the same as those who provide financing for private-equity buyouts and M&A activity. Raising the profile of a business through a transaction, and building quality relationships with local lenders, can often be a helpful starting point for a wider exit in the future.

Given the competitiveness of debt markets, we are seeing more private business owners looking at debt-funded transactions that achieve shareholder objectives. We can help you assess the merits of this approach, as well as delivering transactions, by bringing together the combined expertise of our Debt & Capital Advisory, Tax and Due Diligence teams.

Sajjad Hassam, Senior Manager, Deals

Twitter: @sajjadhassam

LinkedIn: Sajjad Hassam

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