Professor of finance and entrepreneurship
Paris Nanterre University – Paris Lumières University
Doctor of the Business Science Institute
*Faculty member of the Business Science Institute.
Article originally published on The Conversation France.
Each year, approximately 50,000 business sales take place in France. Some individual buyers want to carry out an acquisition project with an investment fund, in order to acquire small and medium-sized companies (SMEs) that they would not be able to finance on their own, with a simple bank loan. They then carry out a "management buy-in" (MBI) operation, acquisition of a company by a buyer outside the target, within the framework of a leveraged buy-out (debt to generate a capital gain), or "leveraged buy-out" (LBO).
This association with an investment fund as a financial partner may in fact prove to be more complex than expected, as we have noted in a recent DBA thesis. Indeed, the inherent stakes of the buyer and the investment fund, which are sometimes antagonistic, in a context where the company is itself under pressure from debt, are likely to give rise to potential tensions between the actors when the entrepreneur-investor dyad is formed and then operates.
First of all, the buyer who wants to initiate an entrepreneurial project does not always have experience in the SME or in the sector of activity of the company he wants to buy. However, they aspire to a large managerial latitude.
For its part, the investment fund's objective is to create value within a finite time horizon, often 3 to 7 years; the creation of value is calculated between the acquisition value and the value of the company at the time of the investment's exit, according to a strategy that aims to buy the company as cheaply as possible and maximize the gain at the time of the operation's exit.
To achieve this, the investment fund selects investments in an environment marked by the scarcity of quality targets. Targets are chosen for their value creation potential, in accordance with the strategy of each investment vehicle.
The companies acquired are also intended to guarantee the interests of the investment fund's subscribers. Capital investors are extremely selective, with eligible targets representing less than 3% of the files studied. Drastic selection criteria, combined with a scarcity of targets, explain why few companies are eligible for an LBO arrangement.
Less than 3% of the files studied by the funds are finally retained.Pixabay, CC BY-SA
The investment fund also selects the buyer, in a particular configuration where the buyer is external to the target. This selection takes place in a context of information asymmetry and adverse selection, a context in which it is difficult to assess the capacities and performance of the buyer, especially when the latter has no entrepreneurial experience.
Misalignment of interests
On the basis of 22 interviews conducted with LBO buyers and investment funds, we have identified some 15 potential tensions of varying intensity that may arise between the buyer and the investment fund, from the "marriage proposal" to the closing of the deal.
Prior to the transaction, the main areas of tension concern the negotiation of the management package (financial incentives for the buyer in case of achievement of the objectives) and the talks relating to the shareholders' agreement (contractual document governing the relationship between partners).
These two areas of tension are characterized by a misalignment of interests between the players. As one buyer testifies:
"These are tense times when we are not aligned with the funds."
The signing of the agreement (or "closing") then marks the beginning of a "honeymoon" between the buyer and the investment fund. The first year of collaboration is characterized by the desire of both parties to work together under the best possible conditions.
This period of relative serenity lasts about three years. However, it is not without its tensions, particularly with regard to the possible underperformance of the company as the investment fund's exit horizon approaches. One fund representative interviewed acknowledges that:
"It's from the third year onwards that the subject starts to emerge. Some LBOs are built over six years and we know very well that the exits are made by looking at the last three years."
However, another interviewee points out that, if performance deteriorates, the quality of the relationship between the buyer and the investment fund is correlated to the level of trust and transparency between the stakeholders:
"The more transparency investment funds have, the less nervous they will be about poor performance."
Finally, at the time of the fund's exit ("unwinding"), tensions may arise due to a new misalignment of interests, when the buyer wishes to buy the shares of the outgoing investment fund or carry out a secondary LBO.
In this case, the buyer, regardless of its capital position, seeks to minimize the value of the company, while the investment fund, wishing to defend the interests of its subscribers, aims to maximize the value of the company. This resurgence of tensions marks the beginning of a period of strong turbulence between the players.
In conclusion, the level of trust between the buyer and the investment fund is the parameter that makes it possible to contain latent tensions and prevent them from becoming salient tensions and becoming a source of conflict that is detrimental to both parties, sometimes irremediably, with repercussions on the company's performance and social structure.
The potential tensions that may arise between the buyer and the investment fund, due to their respective, sometimes conflicting, stakes and objectives, can be detrimental to the creation of value in an LBO transaction. However, these tensions are not inevitable. They can be anticipated, contained and therefore defused.
It should be noted, however, that our work specifically concerns MBI transactions carried out by buyers outside the target company. It would be appropriate to continue the study by analyzing the relations between managers and investment funds in the context of a family transfer or a transfer to one of the employees or in the other families of private equity, namely venture capital, development capital and turnaround capital.
Article translated from French with https://www.deepl.com/translator
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