Looking to acquire an SME, question about LBO model cases and level of risk in classic PE
Hi,
I am in the process of searching for a small company to acquire, and have been struggling to find a target due to the various targets inability to service debt if business declines somewhat. This has led me to pull out of several discussions and I am starting to wonder about my approach.
I am questioning whether I am being too pessimistic/careful when evaluating investment cases (LBO model). Basically, my downside case is always based on declining revenues and slightly worsening margins, leaving the company 10 times out of 10 seemingly unable to service debt to any meaningful degree.
How do you usually think about debt service/leverage/ability to acquire a company in MM PE with regards to safety in a downside case?
Does the company have to be able to service the debt even when facing headwinds, or is this too much to ask for a target?
The targets I look at usually are just about able to service the debt in the base and upside cases, while the downside cases look completely disastrous, leaving me with the decision whether to risk it or not.
Thanks.
My partner is the grand master of avoiding PGs (personal guarantees) and his theory is to break down the other side's needs. What do they actually want when things fall apart? They don't want to sue you personally, take your wife's jewelry and kick your kid out of their home. And very few judges would allow that. And the smart entrepreneurs can protect their assets so well that a PG doesn't really matter. So if they can't mug you in your living room, what will satisfy their needs? Let's break it down; they want to make sure you can deal with tough times - show them your record, they want to have your compliance - offer a document of support, they don't want to sue you for control or receivership - sign a prejudgement remedy, you can agree to every single step which might end in an orderly liquidation and what more could they want? They can hire an interim turnaround manager and end up no better off - minus his fees. Workout and credit officers want an easy life with less assholes then they are dealing with currently. A PG doesn't offer that but a package of compliance does. That's the theory, hard to put in practice. A strong auction process with multiple banks will net you one, especially these days.
Oh, another thought, why do banks give loans to PE groups without PG's? Why the hell should they get that deal and not a scrappy entrepreneur like you?
Ringfencing - study corporate legal structures and read some dull-ass text on what protections an LLC offers. Read the legal text, that's what the judges read. If it's in black text then you can rely on it. When you understand that you can start theorizing on structures and picturing where liabilities go or don't. Then read though asset purchase agreements (boring) and see where these key points are covered. That's it - you just covered the bases from legal text to document and you know how to treat liabilities. Enormous shit moves within lines of text. Then reverse engineer the LOI and think how you'll plant those seeds with comforting text, which they will approve with their signature.
My point on Real Estate investors is that they hold each property in a separate LLC so if someone slips and falls at one property they can't sue the others. Even large property holders like McDonalds or Walmart will do that. Also a PE group will hold all the assets in totally separate entities that allow no cross collateralization and that's what an entrepreneur should do.
Hope that helps.