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FTI Consulting – Perspectives from both sides of the deal: Owner Managed Businesses and Private Equity Investors

Owner Managed Businesses form an integral part of South Africa’s economic landscape.  While some of these have grown to become global conglomerates, there is a plethora of mid-tier Owner Managed Businesses which remain an important part of the growth engine of our economy. Some of these businesses have remained in the same family for generation after generation. Others are relatively young and have only grown exponentially in recent years.

Over the past few decades South Africa’s thriving Private Equity sector has enabled many Owner Managed Businesses to unlock the value in their businesses through well structured, win-win transactions.   To gain a better understanding of the relationship between Owner Managed Businesses and Private Equity investors, FTI Consulting’s latest report, “Experiences and Perspectives of the Partnership between Private Equity Investors and Owner Managed Businesses” explores some of the key dynamics and insights from the perspective of both sides of the deal.

Our findings show that today’s business and regulatory landscape presents a number of challenges for South African Owner Managed Businesses. Owner Managers recognise that Private Equity Investors can help them access much-needed capital for future growth, assist with succession planning, accelerate growth through providing improved access to new markets and new clients as well as meet regulatory requirements, for example compliance with the Broad-Based Black Economic Empowerment Codes.

Yet, they face a number of challenges when evaluating potential deals. They worry about how to pass on ‘know-how’ to new shareholders, for example, and how to determine and assess a fair value for their business, implement better governance practices and effect structural changes to their decision-making processes.  In most cases, the Owner Manager has an emotional connection to their business and needs to feel a connection and partnership with the Private Equity Investor before bringing them into the shareholding and management structure.

On the other hand, Private Equity Investors understand that concluding a deal with an Owner Managed Business is different from a large corporate or listed entity.  Relationships, work ethic and a cultural fit are essential factors of the long-term success of these partnerships.  Private Equity Investors also recognise that they can bring immense value to these types of businesses not only through corporatisation, improvements in governance as well as access to funding, but also through ‘softer’ issues and knowledge transfer in the day-to-day management of the business.

Insights gathered from the respondents demonstrate that because Owner Managers have often invested years of time, effort, emotion and finances to building their business, mutual trust and alignment with the new investor are also key during the process of choosing a prospective investor.

When considering a potential investment opportunity, Private Equity Investors say they look first and foremost for strong, positive cash flows, but a strong management team, opportunity for growth, positive historical financial performance and favourable industry trends are also key considerations.

Other attributes noted include the ability for bolt-on M&A opportunities, digitisation (as both an opportunity and a risk), strong brand and intellectual property.  Culture fit and relationship ‘alchemy’ are additional points that are considered critical for a deal to progress to completion.

Closing a deal with Owner Managers typically takes longer than large corporates or listed entities – with building a relationship and establishing trust between the Private Equity Investor and the Owner Manager essential for progressing the deal. While 33% of private equity investors say deals with Owner Managers are closed within a year, 50% say it takes on average between 12-18 months from origination to deal closure and implementation, with the balance longer than 18 months.

Interestingly, nearly 40% of Owner Managers exit the business with the Private Equity Investor and planning for this is an important consideration before the conclusion of the deal. However, while investors typically exit their investment in the company together with the Owner Managers and the management team, this is not always the case.  For example, where the new investor offers the original Owner Manager and management team an opportunity to reinvest alongside them in the follow-on transaction, or where the new investor requires the management team to remain.

Private Equity Investors indicate that they use a variety of valuation methodologies on a case-by-case basis to determine the value of Owner Managed Businesses. While 56% of respondents use appropriate earnings multiples as their primary valuation methodology, 33% use a discounted cash flow as their primary valuation methodology.  Almost all respondents use a secondary methodology to support and corroborate the valuation range determined by the primary methodology.

When it comes to adjusting for risk, most respondents indicate that risks would be assessed and quantified or captured in the valuation, where possible.  Mitigating factors for manageable risks would be included, such as appropriate deal structuring and appropriate inclusion in the transaction legal agreements, appropriate warranties from vendors, insurance products and adequate, robust succession planning.

What is evident from the responses received from both Private Equity Investors and Owner Managers is that Transaction Advisors play an important role when it comes to private equity deals in Owner Manager businesses – from the early stages of deal origination, Due Diligence and Valuation through to Conclusion.  Most Owner Managers who were interviewed, reported that they used a Transaction Advisor to assist them during the disposal process.

John Geel is a Senior Managing Director and Head of Corporate Finance at FTI Consulting

Media contact: Julie Cunningham: [email protected]

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