Jan 2021 : There is an improved and updated version of this glossary over on the Tenzing Private Equity website where I now do most of my writing.
This is a look at the magical words, abbreviations and acronyms invented by private equity people to make their world understandable to themselves and incomprehensible to others.
If you have any additional items to add, please let me know.
When you run a Process and, hopefully, complete a PE deal there are raft of men in suits (with the very occasional woman) who “help”. As a group they are called Advisors. This group includes your Investment Bank your lawyers and the various due-diligence providers.
Advisors produce two outputs :
- A huge raft of documents of varying quality attempting to explain your business, it’s market, the opportunities and obstacles.
- A huge raft of bills of varying sizes (see “Deal Fees“).
In my experience there is little correlation between the two outputs. The bigger your company is, the bigger “brand” people tend to want on the report then the bigger the bill tends to be.
Annual Strategy Presentation
Some PE firms like you to come and do an Annual Strategy Presentation where you give the Investment Committee an update on what you’re doing and outline what the year ahead looks like.
In my experience these are done very patchily and in nine PE years I’ve only actually done two. In my research for the first one I couldn’t find any commonality of approach from anyone who had done one before.
They seem to have three key purposes :
- Let’s the investment committee have a look at you and see if their Investment Director is holding anything back from them (for example that you’ve lost your mind).
- Let’s them interact through a couple of well meaning suggestions or “challenges”, which generally reveal how little they know about your business and what you’re strugglng with.
- Let’s them tell their LP’s that it’s one of the many ways that they add value to their investments.
These presentations are definitely not something to worry about. But if you’re running a process and one of your PE bidders says they don’t do them, give them a bonus point in your assessment grid.
When you do a deal a raft of advisors will have “helped”. Some of these will have worked for your some will have worked for the PE firm. All of these hungry mouths need feeding and they are fed with “deal fees”.
If you’ve been running a tight business without spending hundreds of thousands of pounds on consultants, these fees will be eye-watering. However they are unavoidable. Fortunately (sort of) they get added to the purchase price of your business so you don’t need to pay for them out of your own cash flow.
So if the PE firm is paying £10m for a 55% share in your business and the deal fees are £2m, then the total cost of the business to them is actually £12m, This is the total deal cost. This eventually gets paid back either from cash you generate during the investment period or by being deducted from the sale price when you sell at the end of the investment window.
The Investment Bank or sell-side advisor gets the biggest cheque – normally a percentage of the price paid. Next biggest cheques go to financial diligence providers, commercial diligence providers and so on down to the smallest players like insurance diligence.
Due Diligence (aka Diligence)
Also see Vendor Due Diligence and Red Flags.
Due Diligence is the process by which a PE firm tries to assess the viability of a potential investment and the accuracy and completeness of the information you have provided.
In truth, much of the heavy diligence is done by the PE firm themselves as their work in deciding whether or not they should invest in you. Then when you’ve accepted an offer in principle, you’ll go into an exclusivity period.
The use of external, specialist advisors to look at your business occasionally finds something that hadn’t been seen before and also covers the PE firm (somewhat) with their investors (the LP’s) if it all goes wrong later.
There are several due diligence projects :
Financial Due Diligence
A report written by accountants on the financial aspects of your business. They will analyse your past accounts, your projections and assumptions and may point out things like customer concentration or any risks that they see. They check you’ve paid your taxes and produce a financial model of the business that will show sensitivities and a range of outcomes.
This is a report written by management consultants on the commercial aspects of your business. They will analyse and explain your market, your position in it, the size of it, it’s growth, your customers and your product.
They will normally interview some of your customers and will try and form a view of why customers buy from you, how sensitive they are to pricing changes, whether they like you a lot or just a little and whether any big customers are thinking of leaving.
They will also look at key suppliers and see if there are any risks or concentrations there. They’ll analyse risk of suppliers disinter-mediating you and going straight to the customer, and the same in reverse for customers.
Most people find the customer interviews part of CDD the most interesting and useful – it’s’ a relatively simple exercise that few of us get round to doing in the normal course of business and it can sometimes reveal surprises. It’s not uncommon to find that you thought customers chose you for one thing but actually they value another.
Other diligence projects that also run in parallel include IT Due Diligence, Management Due Diligence Sales Due Diligence and Insurance Due Diligence. They are normally thought of as the second level of diligence projects – less important. They cost less and the corresponding report tends to be poorer and significantly less useful.
Quite often all of these diligence projects run concurrently and the PE firm is also still doing their own work as well. Everyone is working quickly trying to complete the deal by a deadline so you and your team will be under a barrage of questions every day. That’s why PE processes are exhausting and hugely distracting to the management team. See post-deal slump.
Pronounced “eee-bit-dar”. Get used to this you’ll be saying it and hearing it every second sentence.
EBITDA stands for Earnings Before Interest, Tax, Depreciation and Amortisation of Assets.
It’s the key profit line that PE firms are interested in and it’s the profit line that is used as the measure when valuing your business.
So if your business made £9m net profit, before taking a £2m depreciation charge on equipment and paying tax of £1.5m, everyone is interested in the £9m not the £5.5m of profit that you’ll actually report at Companies House.
This focus on profit before depreciation causes the interesting effect that capital expenditure is ignored when looking at your profit line. So money that you spend on computer equipment, office fit-out and other cap-ex items doesn’t hit your profit line, it’s essentially free. Everyone head down to the Apple Store!
This always seemed odd to me and it results in an annual tussle with the CFO where CEO’s desperately trying to hit their EBITDA budget try and reclassify blocks of expenditure as Capex.
I’ve never fully grasped why depreciation is ignored but it’ll come in handy when you’re up against the wire..
The exclusivity period in a sale process is where the PE firm starts paying hard cash for external consultants to try and confirm what they have found. See Due Diligence
For a typical £10m – £20m investment, the PE firm might spend £300k – £400k on advisor fees so they only do this when they’re serious about completing a deal.
You start an exclusivity period by signing a short agreement or letter saying that you will now deal with that PE firm exclusively and will not talk to others. You’ll put your other bidders on hold so they know they’ve lost (or are likely to lose) the deal.
If you fail to agree final terms during your exclusivity window, or your PE firm pulls out then you can go to your other bidders. In this situation, though, other bidders will want to know why your deal fell apart. This is a situation where it will really help if you did Vendor Due-Diligence as you can take your DD with you to the next bidder.
An “exit” is the name given to the event that leads to some, or occasionally all, investors “exiting” their investment and realising the value of their equity as cash.
Yet another name for your PE investor. They are interested in your business purely for financial reasons. Contrast with a Trade acquirer which might be interested in you for strategic reasons.
General Partner (GP)
Another name for your PE house. The principles in charge of your PE firm might call themselves the General Partners.
Used as in “hockey stick projection” or “hockey stick forecast”.
A surprising number of IM’s include a revenue and or profit forecast which includes a chart that shows a flat line followed magically by a sharp upturn, looking just like a hockey stick.
The company being sold is normally at the end of the flat line, just about to shoot up. If your forecasts look like this then don’t worry, just lean in to it. PE firms are used to seeing them. In fact if your IM doesn’t include a hockey stick somewhere they’ll probably be suspicious.
Investment Memorandum (IM)
A document written by you and your investment bank that explains your business and the investment opportunity to potential investors.
An IM will normally include a description of the business and your products, your market, customers, competitors, risk and opportunities. It’s essentially a brochure for your business so it leans to an optimistic, rosy future.
Also see hockey stick projection which can be found in a surprising number of IM’s.
Not a bank at all, so don’t get them confused with the people who lend you money.
An investment bank is the key advisor you employ to help you sell your business. They make as shortlist of buyers (both trade and PE), produce an IM, run a process and try to maximise value for you. Think of them like an estate agent for businesses.
You’ll pay them an amount of money that would make a casino owner blush.
Also called “the advisor” or “sell-side advisor”
This is the person at the PE firm who is responsible for buying your business. They then sitting on your board, normally for the duration of the investment. Their fortunes are closely tied to yours – they bought you and their reputation is on the line. They will deeply want you to succeed.
So the two people who should wake up each morning working about the business performance and fretting about how to execute on the opportunity are the CEO and the Investment Director who bought the asset.
Investment Directors tend to stay surprisingly long periods with a particular PE firm partly because their earnings are tied to the investment cycle. So they’re on a 6 year delay to get paid their bonus for for your successful investment period.
You should really like the Investment Director that is bidding for you as you’re going to be their partner for the next 4 or 5 years.
Investment Committee (IC)
The group of senior partners and sometimes non-executives that ultimately decide on which asset to buy.
Your investment director will represent you to the IC, will write investment papers explaining the investment opportunity and will answer their challenges and questions.
Investment Committees almost always seem to meet every Monday morning so you’ll find your investment director there presenting nervously toward the end of your process.
Leverage is a fancy word for debt or borrowing money. You need leverage in private equity as most deals are structured as a leveraged buy out.
Leveraged Buy Out
Most PE deals are structured as a leveraged buy out meaning they rely on borrowing from the bank as a way of paying for the acquisition of the business.
The reason for this is that it is cheaper to borrow money from the bank than it is to borrow it (get it through investment) from your PE firm.
A PE firm typically wants to triple the size of its investment over a period of four to five years (any more is gratefully received). Whereas a bank might only want 6% interest per year.
So if you got £10m of funding each from a bank (as senior debt) and your PE firm (as investment), the PE firm would hope you would turn that £10m into £30m, but the bank would only expect £12.6m back.
Banks are cheaper and therefore much more risk averse than PE firms. So a PE firm might value your business at 12x EBITDA but the bank might only lend you 6xEBITDA. The gap in between those numbers in your deal structure is funded by permanent capital.
Limited Parter (LP)
LP’s are your investor’s, investors. They are the people and companies who invested in the PE fund that your business is being bought buy. They are often pension funds, or maybe large family offices.
You may never meet the LP’s unless you’re invited to present at your PE firm’s AGM. But the LP’s will know you and your company from the PE firm’s regular reports.
When you’re already PE backed and sell to another PE firm.
In the old days these deals were seen as bit off. The idea was that a company under PE ownership should maximise it’s lot in life and then do a trade sale. If you sold to another PE firm then you had “left value on the table” for the other PE firm.
This is no longer the case with many companies going through multiple rounds of PE ownership. Some PE firms have even been known to buy back assets that they owned previously, wanting a second spin on the wheel .
This is any money that is borrowed that ranks (in terms of who gets paid back first) senior to the investor. So this is normally a fancy word for money you borrow from the bank. (See Leverage and LBO).
You can borrow money for normal business investments but in the context of a PE dea, the first and primary use of bank debt is to to part finance the company’s acquisition by the PE fund in the first place.
Bank debt normally ranks ahead of any other debt or loans so it is paid back first when you sell or refinance. Bank debt is low risk, low return.
The “management” of the company – essentially you and your team. Used as in “let’s ask Management” or “how are Managenent doing“, or “Management – keep / replace?”, which I once saw on an investors evaluation template!
Right at the very end of the process, when you’re absolutely exhausted from several months of questions, diligence, presentations, advisor calls and working through issues and documents are the Management Dinners.
This is where you and your executive team go for dinner with your final shortlist of PE firms in order that they can confirm that you know which way to hold a knife and fork.
PE Investment Directors tend to be very charming and most have surprisingly good social skills given that they are accountants. So dinner with them in a fancy restaurant wouldn’t be the worst thing were it not for the timing. At this point in the process you are knackered and really want an early night.
Market, as in “The Market”
“The Market” is the collective name for all of the advisors and people swimming about in the PE pond when the person talking doesn’t want to reveal who said what.
So when someone says “Feedback from the market is that so and so is going to get their offer rejected”, it translates to “An advisor told me in the pub last night something that is supposed to be highly confidential”.
One of the things you learn about PE is that it’s a small pond, full of gossip and all the advisors end up working for everyone. Information is power, power is money and to all gets traded on a nightly basis in the bars and restaurants around Mayfair.
An funny name for money that’s somewhere between bank debt and investor debt.
More risky than bank debt and therefore more expensive. Less probably much less, risky and less expensive than investor debt.
Capital (money) provided by the PE investor from their PE fund. This is expensive capital compared to bank debt. Normally put into a business with a matching loan note so the capital amount itself is protected if the equity price falls to zero.
PE investors want a return of 2.5x – 3x on their permanent capital. Some investments “pop” and can do 4,5,6, 7x or more.
This is a list of things to work on after the deal is complete. Sometimes called the 100 day plan as there is a hope that it might all get done in the first 3 months.
As you go through your process, your investor and diligence providers will unearth things that are not ideal or need to be fixed but are not severe enough to derail the acquisition. These get dropped onto the post-completion plan.
Don’t worry too much about this, just let it happen.
Once completion is done and you’ve had a holiday you can re-look at the list and edit then – its much easier to have the argument that something isn’t really important at that stage.
It’s not uncommon for an asset to grow slower during the first year of PE ownership than before. In fact some companies can struggle or even go backwards in year 1 and this is a situation reported by many of my CEO colleagues in PE and a number of PE funds.
The reasons for this can include :
- The management team has been hugely distracted for the nine months prior to the sale (by doing the sale) and that can impact negatively on product, business and organisational development.
- The management team is exhausted by the sale process, confused by their new ownership structure and struggling under the weight of “helpful” suggestions from the diligence providers
- Trying to do too many new things at once in an effort to grow the business faster actually makes it go slower. A classic example of this is adding too many new sales people that then consume management resources to recruit and train so sales go backwards not forwards.
- In an effort to maximise the sale price, your sell side advisor persuaded you to stretch all of the projections to the fringe of reason and in year one you have the hangover from that party!
Normally the bulk of your purchase price is paid in permanent capital, with the rest being paid by senior debt then management rollover.
A process is the project that results in an exit. So you’ll hear things like “Company X has just started running a process”.
A process involves management, investors and advisors, normally an investment bank who manage the process as your representative to the market.
For all the money that you spend on due diligence you would think they would come up with something concrete that you can rely on. This is not how it works.
Due Diligence Advisors try and get away with saying as little as possible that they can be sued for in the future. So getting them to say anything concrete is like trying to catch a slippery eel. Some even go so far as stamping “Not to be relied upon” as a watermark in the document!
An advisor will never go so far as to say that an business is a good or bad investment opportunity.
So instead of putting themselves on the line, they’re main output is to raise “red flags” which are things that might be something to worry about. It’s then the investor’s job to work out of the red flags are real deal-breakers or not.
Some red flags may get dealt with in the Post-Completion Plan or 100 day plan.
This is a very short document, often a 2 page PDF that your investment bank sends out to flag to the market that you’re thinking about a process. It includes some very high level information on your business and its key job is to see what the initial market interest is.
A teaser is really the first outwardly visible part of your process, assuming your appointment of advisors has remained a secret.
Trade Sale or Trade Deal
When you sell your business to another business, sometimes a competitor rather than a financial sponsor like a PE firm. Also known as “A Strategic”, eg “They sold to a strategic”, meaning they sold to a strategic buyer.
Strategic buyers are revered because they can, and often do, pay more for a business that PE can because they are buying for a strategic reason, rather than a purely financial reason. See this article for reasons why.
Vendor Due Diligence (VDD)
Due Diligence is something the buyer performs on your business in order to prove or disprove that your business is an asset worth investing in. But if you, the vendor, are confident of completing a sale you can commission the diligence yourself – this is called Vendor Due Diligence.
The advantage of VDD is that you own it so it puts your in much more control of your process. If your discussions with one PE firm break down, you can take your IM and your VDD to another PE firm and continue a discussion there. The downside is that you have to pay for it and if a deal doesn’t happen you won’t be able to bury it in the deal fees.
You will use the same advisors to do the DD as your PE firm would – they’ll take money from anyone. But a second advantage is that they’re working for you, whilst attempting to keep some semblance of professional independence, so you will see many drafts of the DD report and can tell them when they’ve got the wrong end of the stick. This is hugely preferable to buyer-DD where you might never see the report and your potential buyer could make a decision based on flawed information or analysis.
Back in 2010 when I did my first deal, Vendor DD was still a bit special, but now in 2020, it’s very normal. I highly recommend it because it puts you, not the PE firm, in control.
Venture Capital or VC investors are very different to private equity investors. They invest in startup and early stage investments, pre-revenue, pre-profit, often even pre-product.
By contrast, PE investors specialise growing, profitable cash generative businesses.
This different approach hugely affects risk, ambition, deal structure and outcomes for entrepreneurs.
More in this article “Private Equity versus Venture Capital. What’s the difference?“