Why some entrepreneurs give up a slice of their business to investors

Aug 29 2007 by Tony McDonough, Liverpool Daily Post

PRIVATE equity – a force for good, or as one union leader put it, the “provisional wing of capitalism”? The recent House of Commons investigation into the sector was, at times, not a pretty sight. MPs gave industry representatives a grilling, questioning whether their activities were to the detriment of British industry.

Following the takeover of companies such as Birds Eye, AA and here in Merseyside, Burton’s Foods, there were accusations that the industry was maximising revenues at the expense of good service and jobs.

MPs also questioned the tax breaks enjoyed by those involved in private equity (PE) and inquired whether such deals were laden with too much debt. One boss admitted he was paying less tax than his cleaner.

This very public process has been viewed with dismay by PE players here in the North West who argue their sector is in fact a force for good, allowing companies large and small to fulfil their potential and grow employment in the process.

So what is PE? The sector provides established businesses with long-term share capital which will allow them to expand. Bringing PE into a business is very different from raising debt finance from a bank.

A bank has a legal right to interest and repayment of capital on a loan and will be knocking on the door demanding its money, irrespective of whether the business is a success.

Private equity backers will actually take a stake in the company and, where appropriate, will take an active advisory role in the running of the business. Their return on investment is dependent upon the company becoming more successful.

PE investors will seek to increase a company’s value to its owners, without taking day-to-day management control. Although the owner may have a smaller slice of the businesses, within a few years that slice should be worth considerably more than the whole firm was before.

Deals can take the form of a management buy-out, management buy-in, complete disposal or simply a way to raise extra capital.

Gareth McIntegart, a corporate partner in the Liverpool office of law firm DWF, said: “PE can be a useful funding option for smaller companies. While there are few PE houses interested in investments of less than £2m, above this level there are a range of players who are active in the market and keen to invest in Merseyside businesses.

“PE can offer significant advantages over other types of funding, which explains its popularity with owner-managers seeking capital for expansion or to realise part of their investment in the business, and teams undergoing a management buy-out.

“A PE investor will require you to give up some of your equity in the business, but if the company grows rapidly, as many do, you will end up with a stake in a much larger operation.”

Experts in the sector now believe that Merseyside is coming onto the radar of major private equity houses in the North West after several years of relative quiet.

Up until about five years ago the corporate finance market in Liverpool was reasonably healthy but then, one by one, the corporate finance teams of major accountancy firms like KPMG and Ernst and Young withdrew to Manchester.

These so-called “rainmakers” help make deals happen by aggressively identifying opportunities. Since the exodus such individuals have been thin on the ground. Accountancy firms will insist they are still doing deals in Merseyside but the teams often operate from Manchester or other parts of the region.

Paul Lupton, head of corporate finance at Deloitte in the North, said: “Private equity houses have clustered in Manchester, meaning that a lot of deal activity originates from that city. This should not be viewed as a disadvantage to Liverpool or Merseyside, far from it, as corporate financiers in Manchester work closely with Liverpool professionals to construct and develop deals.”

When Ernst and Young withdrew to Manchester the leader of its corporate team, Steve Stuart, jumped ship and set up his own operation called the Steve Stuart Partnership.

Since its formation in 2002 the firm has forged close links with Merseyside Special Investment Fund (MSIF) and the Liverpool Seed Fund, helping to keep the local market alive.

He said: “Liverpool has never been the best place to do business. About 50% of our economy is public sector and the public sector does not do corporate finance.

“For the last 10 or 12 years you have had MSIF and they have helped create a bit of a market and I think now the city is ready to move on. There are entrepreneurs out there with money to spend. They might say, well the stock market is looking a bit dodgy and so is the property market and it’s a case of getting them to invest in business.

“We have had a better pipeline in the last three months than we have had in the last three years, but there is still a long way to go.

“What we need is everyone in the city working together and we also need to educate professional advisers about what it is entrepreneurs need. This is something we are trying to do through Professional Liverpool and it is something I am passionate about.”

One of the rainmakers helping to drive this change is Paula McGrath. A big hitter, she was brought into the Liverpool office of PKF last year to head up its corporate finance team and help to shake up the local market.

She had previously held senior positions with BDO Stoy Hayward in Liverpool and, most recently, Ernst and Young in Manchester, where she specialised in mergers and acquisitions and played a leading role developing a successful private equity practice.

When she arrived in the city last October, she said: “Liverpool hasn’t yet reached its potential for professional corporate finance expertise and service, despite being home to some of the most successful companies in the north of England. This gives us an opportunity to capitalise on a gap in the market that we’re confident we can fill.

Since then Ms McGrath has been true to her word. She and her expanding team have been lead advisers on no less than seven deals. Three alone were completed during June with a combined value of £25m.

The biggest deal it has been involved in to date was the sale of Liverpool Football Club to US tycoons Tom Hicks and George Gillette in a buyout worth just under £220m.

“Before I came back to Liverpool I was getting mixed messages about how much potential there was for deals in Merseyside, but when I got here I was pleasantly surprised,” said Ms McGrath.

“I was a bit unsure because there were not many other advisers in the city involved in corporate finance. There were some firms doing due diligence work but none really prepared to actually generate deals.

“Since we came here we have now seen private equity firms like Gresham and Aberdeen taking a closer look at Liverpool.

“There are a significant number of family firms in Merseyside who are being run by the third or fourth generation who might be looking for an exit or just want some assistance to grow the business.

“For some selling up is not something they want to do but you can often do a partial deal where they give up some of the equity to external investors who can come in and be a good sounding board and give them the benefit of their industry experience.”

MSIF provides loans and equity packages from £3,000 to £4m to businesses based in or relocating to Merseyside.

Mark Fuller, the managing director of Alliance Fund Managers, the fund management company that manages MSIF’s funds, said he was seeing some “green shoots” of recovery in Merseyside’s corporate finance market but added there was still a “long way to go”.

“We are very busy at the moment,” he said. “In the last three months we have invested around £6m but each time we have to work very hard to get it over the line.

“Merseyside has some great businesses and some great entrepreneurs, and many of them have had to soldier on through some very difficult economic times all by themselves. But now the professionals, the rainmakers, are starting to come back.

“It is now a question of educating business people in Merseyside on the art of the possible. I believe things are happening but it is going to take a long period of time.”

Steve Stuart did raise a concern about whether the value of potential deals was enough to attract some PE houses into Merseyside.

“The size criteria for some of them is getting bigger and so a number of potential deals here may be slipping under their radar,” he said.

Peter Armitage, a partner at PE firm Key Capital Partners, acknowledged this was the case, adding it was the same for the bigger accountancy firms.

The company, which operates out of offices in Cambridge and Leeds, specialises in making equity investments of between £1m and £5m, just the right bracket for many potential deals in the Merseyside market.

“This is where we have seen a gap in the market and we are just about to do our first deal in Liverpool, with a second one on the way,” he said.

“Having active advisers on the ground makes a big difference because they can stir up the market and make things happen.

“We are starting to see that now with firms like Steve Stuart, Brabners, Langtons and PKF.

“I don’t think the recent publicity has done us too much harm. In fact, it has helped people understand better what we actually do. We would typically invest for a three to six year period and what we are about is actually growing those businesses.”

Buy-out managers make the most of private equity

A SOUTHPORT business that mends the watches of more than 500,000 people a year was acquired by its management team in a £1.75m private equity-backed deal in April.

In Time Watch Services operates through a national chain of 55 outlets in major stores including Debenhams, Beales, House of Fraser and Tesco.

The company offers watch repairs and servicing and provides replacement parts including straps and batteries. The company also sells leading fashion brand watches, including DKNY, Adidas, Fossil and Diesel.

The funding package to finance the acquisition and expansion of the business included £1.142m from Merseyside Special Investment Fund’s Venture Fund and directors’ own investment.

In Time’s management team consists of managing director Angus Matheson and operations director Brian Jones. The company has also appointed David Edwards, former managing director of Max Spielman, as chairman.

Mr Matheson said: “The investment from MSIF is crucial and we can now significantly expand the business. We are looking at lots of new concession opportunities and potential acquisitions.

“In addition to finance, MSIF also helped source David Edwards through their extensive contact network and his appointment is invaluable given his wealth of experience.”

In Time currently employs 150 staff at its branches throughout the UK, and expects this figure to increase by up to 50% over the next three years. Turnover last year was £4.7m and is estimated to rise to £7.8m over the next five years.