According to private equity industry analyst Prequin, North American private equity companies are now sitting around $1 trillion in dry powder and approximately $3 trillion in AUM. Private industry deals will flow in the upcoming 2 to 3 years. Various portals work with dozens of private equity firms at every stage of their deal process, from its inception to due diligence and post– deal issues. It has given unique perspectives on recent movements in the industry and some more general insights.
So, in this blog, we share a complete guide on how to structure a private equity deal and what is included in it. So, let’s discover.
What are the Steps of a Private Equity Deal?
Sourcing and Teasers
Starting a private equity deal structure is called deal sourcing, which includes finding and evaluating an investment opportunity. PE deals are searched through various approaches like equity research, networking, cold – calling executives of target companies, internal audit, and many more.
On the other hand, a Teaser is a one or two-page conclusion sent by a financial intermediary about an organization up for sale or a private equity investment opportunity. However, it does not disclose the seller’s name but only a detailed description of products and services and key financials. Organizations hire investment banks to attract PE firms and strategic buyers.
Signing Von – Disclosure Agreement (NDA)
If PE firms are interested in the teaser’s prospects, they must sign NDA. After signing NDA, the financial intermediary will provide the PE firm with Confidential Information Memorandum (CIM). It includes financials, capital structure, thesis, and projections. If an investment opportunity is sourced, then this NDA is confirmed with the Target Company. After that, the management of Target Company provides private data regarding business. During the process, PE firms are provided with lots of data to decide whether they are interested in the opportunity.
Initial Due Diligence
In this stage of the PE process, initial due diligence is conducted to understand the target company better. It includes research and collecting information about the organization and its industry. Another significant section of due diligence is an estimation of return on investment according to projections offered by company management.
The investment team will create and send this proposal to its investment committee. The reason for the first investment committee meeting is to change from one PE firm to another. It may be simple deal updating or starting the formal approval process. After that, the investment team allows spending on consultancy and other expenses.
First Round Bid or Non – Binding Letter of Intent (LOI)
In this stage, the investment team will offer Target Company with non – a binding letter of intent for the transactions. It is specific criteria provided to them by Target Company’s management. Also, the valuation range is defined instead of a particular amount. However, the target company and its advisors will select a bid and move ahead to the next round in the auction process. Here are a few crucial points that are taken into consideration:
- Value creation planning
- Buying price
- PE firm experience and expertise
- The credibility of the offer
- Compatibility with the submitting firm management team
- Time required to provide a binding offer
- Post-acquisition capital structure
Further Due Diligence
In this stage, the sellers will provide many other confidential data.
- Board reports, including meeting minutes
- Employee details
- Employee agreements
- Company legal and organizational entities
- Documents related to intellectual properties
- Operation record
- Financial information
Create an Internal Operating Model
An operation model includes detailed and divided detailed revenue and cost breakdown. It includes critical drives of the target business and assumptions into consideration. Key drives many changes according to the deal, but some common ones are:
- Raw material costs
- Number of customers
- Renewal rates
- Fixed vs. variable cost structure
An investor uses this model to predict the target company’s financial performance. It gives PR firms’ makers a clear view of the significant factors that drive return for the acquisition.
Preliminary Investment memorandum (PIM)
The Preliminary Investor Memorandum is a 30- to 40-page document summarizing the investment opportunity for the PE firm’s investment team. The following sections are usually found in the Preliminary Investment Memorandum:
- Executive Summary - Important details like the transaction, background, and recommendations from the deal team and the investment thesis.
- Company Overview - The target company’s description, products, services, history, competitors, customers, and organizational structure. Also, biographies of key management.
- Market & Industry overviews– Market growth rates and trends.
- Financial Overview - Past and projected income statements and balance sheets. Also, analytics of cash flow.
- Key Areas and Risks - Due diligence discovered the most likely risks to the business and industry.
- Exit Details - Options when it comes to exiting investment and timing.
- Proposed Project Plan - Recommendations to the committee about how to proceed with this project based on a range of valuations and a budget that the investment committee approved.
Due to high costs, deal teams typically only perform the initial due diligence. Private equity Industry owing diligence frameworks include additional legal and due diligence.
Final Due Diligence
After the investment committee has approved the PIM, the PE deal team will perform the final due diligence. This stage is when the investment team focuses on this project. Other PE projects may be delegated to professionals or sidelined. During this private equity investment flow chart stage, the deal team interacts daily with the investment bank and Target Company’s management.
They will contact the target company with any outstanding issues, such as visits and calls with sales staff, non-executive managers, customers, and suppliers. The investment team will oversee the consultants during this period. They will also manage other streams of due diligence, such as legal, financial, and commercial. They will also begin negotiations with banks regarding debt financing options. This is to ensure the best possible terms for a group bank. The due diligence process for private equity usually takes three to six weeks, starting with the First Round Bid and ending with the Final Binding Bid.
Final Investment Committee Approval
After completing all the processes and the investment company is ready with the deal, the final investment memorandum (FIM) is created. The FIM will address the due diligence carried out by the deal team and its consultants from creating PIM, explicitly highlighting the investment committee’s points. The deal management team will also advise on specific valuations to acquire Target Company. The valuation may be approved or rejected by the committee.
Final Biding Bid
If the FIM is approved, the deal team will send the target company a Final Binding Bid or a Final Round Bid. The bid includes the final buying price, financing documents from the investment bank, and preliminary merger agreements. The seller’s lawyers will discuss the prior merger agreements later. After reviewing the bids received, the seller and their advisors will spend at least one day deciding on a winning bid.
Signing the Deal
After the seller and its advisors and investment bankers have selected a winning bid, they will only work with that preferred party to execute transaction documents and contracts. After negotiations between the lawyers representing the seller and buyer, a Purchase Agreement (or Merger Agreement) and other documents are created.
The entire process, from evaluation to completion of a new private equity investment venture, is lengthy and exhausting. However, the steps mentioned above may vary from one firm to another, but some are common. It is due to its significance in ensuring a successful private equity investment.