Transactions Blog

To meet their performance objectives, private equity firms must rely on talented, highly motivated managers within their portfolio companies.

To date, aligning the financial interests of portfolio company managers with those of investors has proved to be the most motivational tool in driving them forward. But is this alignment still there in the current financial and economic downturn, which may have resulted in a drop in  enterprise value?

One consequence of the current financial and economic crisis is that private equity houses may have to cope with “underwater” equity and should consider resetting management incentives so that they continue to deliver what they are intended to: retention, motivation, reward and alignment. The question is how this resetting can be appropriately structured from a tax and legal perspective.

In this respect it may be helpful to think of a deal as a “cake” with the debt and equity forming various slices. Resetting the incentive may be done by waiving shareholder debt, reducing or turning off the coupon on shareholder debt, converting shareholder debt into equity, restructuring management’s holding to rank ahead of shareholder debt, amending equity, creating new ratchets, creating preferred shares, granting  share options and so on

All the alternatives will potentially result in additional value flowing into the sweet equity held by the portfolio company managers and may potentially trigger a tax and social security tax cost for management in most jurisdictions. From a Belgian tax perspective, private equity houses might validly consider granting share options to structure this flow of value to sweet equity. The advantage of share options is threefold: a proven tax treatment, high flexibility in defining the share option features, a lump-sum taxable value that could prove to be far below the actual option value.

Feel free to contact our Management Participation Team for any questions you might have in respect of resetting management incentives held by your portfolio company managers.

How cheaper are companies being sold nowadays? After a long period of almost flat purchase price multiples, these are now falling significantly. The average purchase price multiple in Q3 2008 fell to 8.7x EBITDA, well below 10.5x EBITDA the quarter before. Psychological resistance for vendors to accept the new market conditions clearly changed and need to further change.

 Average LBO debt multiples (if any …) declined markedly as compared to previous quarters, in line with the fall in purchase price multiples. The decrease in debt multiples is partly explained by more post crunch deals launched to the market this quarter, thus lowering the debt multiples. In Q3 the average total debt to EBITDA multiple had dropped to 4.5x, well below 5.5x for Q2.

 What is interesting is that while debt multiples are now closely in line with 2004 levels, purchase price multiples have only decreased to 2006 levels. This discrepancy is due to the larger equity cheques now being written by sponsors.

 Indeed, equity contributions at 3Q2008 ended the quarter at 43% (as compared to c. 34% a year ago). For the first time since S&P started tracking the leveraged loan market, private equity sponsors are contributing more cash to buyouts than senior lenders. In an average buyout launched in 2008, average equity contribution is c44% (2007: 34%) while first lien bank debt contributed 41.6% (2007: 49%).

Reducing number of transactions, plunging equity markets, falling consumer confidence, tumbling oil price, … Could any month be worse than December 2008 ? Amid this turmoil, or shall I say in spite of this, we decided to launch our PwC Belgium Transactions blog. Because we want to communicate with our clients on the transactions environment relevant to Belgium.

The talk of the town these days is “when will the market catch up?”. Few months ago it was “after Christmas”, now some say “forget 2009”.

Our English colleagues in Debt Advisory are publishing an interesting paper on the Debt Market Outlook for 2009. Q1 2009 could see a temporarily return of some level of liquidity. After which the impending worsening of the recession will force the intensive care departments of the banks to run on double shifts.