In this article, we focus on some of the dynamics of 'buy-and-build', a strategy popular in the private equity industry for accelerating business growth and value – particularly in times of slow economic growth – with five things to consider when undertaking a 'bolt-on' acquisition (an acquisition by an existing investee company).
1. Management Equity
Undertaking a bolt-on acquisition can present an issue in terms of how management equity is allocated between the original investee company's team, and the incoming management of the target business. Unless provided for in advance, the issue of new equity to incoming managers can be dilutive of the existing management team's equity, so they (and perhaps the sponsoring PE house) may feel there is no 'room' in the equity for a new team. Further, if new shares are to be issued to incoming management, all parties will have to consider the value/price of those new shares – has the equity value of the original investee company shifted (including for tax purposes) since it was originally acquired?
Potential issues relating to participation in the management equity pool can be mitigated, in part, by agreeing at the outset that a capped pot of equity (i.e. unissued shares) will be 'reserved' for future issue to incoming management, and will initially be dilutive of all shareholders (including the PE house), but should in the longer term drive up the overall value of the combined group by incentivising the incoming managers. The issue price for those new shares will need to be assessed on a case by case basis.
An alternative is to establish an employee share option plan, which avoids diluting existing shareholders (including existing management) and can be structured to be just as tax efficient as share ownership.
2. Debt Finance
If the acquisition of the original investee company was debt financed, the finance documents will typically contain lender consent requirements and controls that will, among other things, restrict further borrowings and the granting of further security. If the bolt-on is to be debt financed, the buying investee company will need to either increase the size of the existing facility to effect the acquisition, obtain lender consent to permit new borrowings, or consider refinancing the pre-existing debt. This may not be a simple process, particularly if market/economic conditions and/or the finances of the original investee company have changed, and there may be break/consent fees to pay. The existing lender (in the case of an extension or consent to new third party borrowings) or new lender (in the case of a refinancing) will also require extensive information about the additional businesses being acquired.
Having acquired the bolt-on business, the buyer must begin the task of fully integrating it into the group. It is particularly important to consider how to integrate the two management teams and, potentially, different working cultures, to ensure the smooth and uninterrupted conduct of business, and remain sensitive to any impact that the timing or method of re-branding of the business could have on its existing customer base.
4. Managing Core and Non-Core Assets
The buyer should consider whether – in the long-term – it wishes to retain the entire bolt-on business, as some parts may not be complementary or value accretive. If not, consider whether it is preferable to tackle this upfront, for example by structuring the bolt-on as an asset or business (i.e. not a share) transfer and 'cherry-picking' the desirable assets only, or by planning for a post-completion disposal of the non-core parts of the business.
Note that an asset transfer can be more complex – it takes time to identify the relevant assets, ensure they will transfer without financial impact on the business (e.g. customer contracts) and understand whether there is any reliance on non-transferring assets or services, such as IT and finance functions.
On a transfer of a business as a going concern, as opposed to a share transfer, the buyer should also have regard to employment law (the Transfer of Undertakings (Protection of Employment) Regulations 2006, as amended, known as "TUPE"). Equivalent rules will apply in other EU member states, as TUPE originates from an EU Directive. In brief, the legislation protects against variation of employment terms and dismissal (including by providing for automatic employee transfer to the acquiring company) in connection with a business transfer, and can require employee and/or trade union consultation before the transaction completes.
A post-completion disposal of non-core assets could avoid delay in executing the bolt-on acquisition, but it is important to assess up-front whether there are likely to be any potential buyers for those non-core assets. It will also be important to identify if there are any legacy liabilities relating to the non-core assets in the relevant companies.
5. Competition Law
Where the bolt-on involves the acquisition of a competitor or consolidation of a particular sector within the UK, then the buyer will need to consider the UK Competition and Markets Authority (CMA). The CMA are interested in transactions where:
- the turnover of the target company is more than £70 million; or
- post-acquisition, the buyer company and the target will together buy and/or sell 25% or more of the relevant goods and/or services in the UK.
If the combined groups would have a total worldwide turnover of EUR 2.5bn or more and EU-wide turnover of EUR 100m or more, then EU competition law could also apply (note: further criteria apply which could still exclude such a transaction from the scope of EU competition law), and specialist advice should be sought.
Other local competition laws may also apply, depending on the home and trading jurisdictions of the buyer and the target business.
It is important to seek advice early in the transaction process, as competition law notifications and clearances can have a direct impact on timetable and deal certainty.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.