Valuation modelling course

For a course on modelling debt free cash free valuation click here: valuation training course

Financial modelling course

For a course on financial modelling for LBOs click here: LBO course

New financial modelling course from FTA Ltd

Financial Training Associates Ltd has just announced the release of a newly designed financial modelling course. According to Joanna Smith, business development director, the new course is specially designed to help delegates working in finance-related jobs and who are looking for help with buy out (LBO or MBO), valuation or merger modelling training. "This course is run in an interactive, participative format, where participants learn by doing." The course has been developed in response to recent demand. Much of the course work involves Excel modelling and analysis, equipping participants with the tools to analyse leveraged acquisitions, building up from partially-complete models, working with integrated financial statements, developing an acquisition structure and modelling instruments, running scenarios, iterating and optimising. "As part of their work on this course delegates model transactions based on real-life companies and scenarios." For further details, please see FTA Ltd's online course calendar.

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See http://www.cpd-courses.org/CPD-course-subjects/free-CPD.htm for a free CPD course from Financial Training Associates Ltd

 

 

Free CPD from ACCA and FTA Ltd

FTA Ltd and ACCA have teamed up to make free financial training material available at no cost to interested professionals.

If you work within law or finance this is a chance to "look over the fence" at some of the big issues your clients worry about. If you work in accountancy or along side accountants, this is a chance to reflect on matters that you might have to deal with just once in a while. The training material is especially relevant for professionals who work in financial services or advise on company sales and acquisitions.

Click here for details: free financial training

Bookmark this page if you think you could be running short of CPD points at the end of your CPD year.

FTA Ltd is a specialist provider of CPD courses. ACCA (the Association of Chartered Certified Accountants) is the world's largest international professional membership body for accountants.

FTA Ltd and ACCA have teamed up to make CPD material available free of charge to members and other interested professionals.

The material can be found on ACCA's website at http://www2.accaglobal.com/members/publications/accounting_business/CPD/debtfree and on FTA's website at "free cpd for law and accountancy".

The material consists of a short self study article together with an interactive multi-choice quiz and should take approximately one hour of your time.

CPD update for law, accountancy and banking: issues when buying, selling or financing a business

Free CPD for law and accountancy: this CPD training update looks at how consideration should be determined when buying, selling or raising finance for a business.

The material consists of a short article and a 10 question online multi-choice quiz. It should enable you to claim one CPD hour.

If you think you may be running short of CPD points at the end of your CPD year. Please bookmark this link: valuation training.

CPD training courses from FTA Ltd

Training provider FTA Ltd has announced the development of a new range of CPD courses.

FTA specialises in CPD training courses for lawyers, accountants, bankers, finance and other professionals.

According to Jo Smith, business development director, the new grouping of courses has been developed in response to recent customer demand.

“We have a large range of courses, but we find that law and accountancy customers regularly enquire about some of those more than others.”

We thought it made sense to group some of our most popular courses in one place on a special CPD website, so that’s what we’ve done now”

Details of FTA’s new courses are available at http://www.cpd-courses.org.

FTA Ltd is a specialist training company providing CPD courses for law, accountancy, finance, banking and other professionals.

Free CPD for law and accountancy from ACCA and FTA

FTA Ltd and ACCA have teamed up to make free CPD training material available at no cost to interested professionals.

If you work within law or finance this is a chance to "look over the fence" at some of the big issues your clients worry about. If you work in accountancy or along side accountants, this is a chance to reflect on matters that you might have to deal with just once in a while. The training material is especially relevant for professionals who work in financial services or advise on company sales and acquisitions.

Click here for details: free cpd for law and accountancy

Bookmark this page if you think you could be running short of CPD points at the end of your CPD year.

FTA Ltd is a specialist provider of CPD courses. ACCA (the Association of Chartered Certified Accountants) is the world's largest international professional membership body for accountants.

FTA Ltd and ACCA have teamed up to make CPD material available free of charge to members and other interested professionals.

The material can be found on ACCA's website at http://www.accaglobal.com/members/publications/accounting_business/CPD/debtfree and on FTA's website at "free cpd for law and accountancy".

The material consists of a short self study article together with an interactive multi-choice quiz and should take approximately one hour of your time.

Solicitors Journal: A Smart Move

It may not officially be the solicitor's job to take into account working capital when acting for a client selling their business, but for the smart practitioner who wants to keep their client happy it is worth considering from the outset, says Joanna Smith.

You may have been fortunate enough to have spent time advising a client selling a business. That client may have spent years building their company. A large proportion of their personal wealth will probably be tied up in its sale. It is likely they will be finding the whole process stressful and very quickly you will have learned that there are plenty of ways your client can become a little grumpy. And it’s probably the grumpy clients who most resent paying their legal fees. You don’t want a grumpy client.

A quick master class: winding up a business owner

One of the quickest ways that a business owner can become upset is if he suffers a last-minute price ‘chip’. That is, a price reduction late on in the process.

So, what is working capital and what is its role in a last-minute price chip? What’s the possible impact on a deal? No one working on a transaction is thinking that working capital is the solicitor’s responsibility. But is there anything the streetwise lawyer could look out for? When might working capital become an issue? What kind of things could be done during the process to avoid the last-minute price chip?

Even if it’s outside your responsibilities, a few well-chosen words in your client’s ear and you could suddenly find you have become endearing. This of course is no bad thing, given you are hoping your client will only be too happy to write out a cheque for your services later on in the process.

Working capital: a plain-English guide

Working capital is the funding needed to operate a business over the short term. If customers are paying more slowly, less cash is flowing into the business. More short-term funding is required to keep the business operating. Working capital requirements have increased.

Alternatively, if a business is able to delay paying its suppliers, short-term cash outflows and short-term funding requirements drop. A delay in supplier payments results in a reduction in working capital requirements.

Business change is going to drive working capital requirements. Working capital and short-term funding requirements are going to increase for the business whose suppliers suddenly demand to be paid more promptly, or the business that has to wait for more cash from customers. Any increase in the lag between suppliers being paid and customers paying is going to drive working capital and short-term funding requirements upwards.

So, a business that is growing quickly might have high working capital requirements. Doing more work for more customers means more cash is required to fund activities.

A company that is developing more business with a longer delay between doing work and getting paid will see its working capital requirements increasing. Think about a company diversifying into oil exploration or drug development. A business that is becoming more seasonal, manufacturing in one part of the year and selling in another, might also see working capital requirements increasing.

For some businesses, working capital requirements are going to be a bigger issue than others. Contrast the rapidly expanding Christmas tree producer (scaling up quickly, long production cycle, seasonal business) against the well-established greyhound race track operator. In one of these businesses we might expect working capital to be more of an issue than the other!

Solicitors and other advisers: what’s the impact on deals?

When purchasing a business we can almost predict that the buyer’s accountants will try to use financial data to argue that the target business has higher than anticipated working capital requirements.

What’s the impact? Put simply, identifying higher than expected working capital requirements gives the buyer all the ammunition they need to try and reduce their asking price.

The buyer may argue that the seller has mis-represented the working capital requirements for the business. The buyer might argue that it is raising all the debt it possibly can as part of the purchase. The buyer has to keep some debt facilities in reserve to fund the unexpectedly high forecast working capital requirements.

With the new information, it appears that not all of the debt raised can be paid out to the seller. The seller is presented with a last minute price reduction: a last minute price ‘chip’. If the seller has been dealing exclusively with one buyer, and other potential buyers have left the process, the seller may feel they have little option but to accept.

Preparing for the debate

Think about the rapidly expanding Christmas tree producer. The owner of that business knows a lot about selling Christmas trees and even a little about managing working capital. Unfortunately, having never sold a business before, they may be blissfully ignorant regarding last-minute price chips. Fortunately, that same client has had the presence of mind to retain a commercially-focused streetwise solicitor who has invested carefully in their own CPD (and studied this course material carefully).

What could the seller of the rapidly expanding Christmas tree producer do to prepare for a debate about working capital requirements?

The ‘do nothing’ strategy

‘Do nothing’ is always a possibility, and it’s not completely without logic. The argument here is that the buyer might not raise working capital as an issue at any point in the process. The seller bargains on buyer ignorance or stupidity or the seller’s own absolute confidence that any detailed investigation will show that the business is being sold with a robust working capital position.

However, ‘do nothing’ could be a very risky strategy. The buyer’s accountants expect to be rewarded handsomely for the work they are doing to investigate the finances of the target acquisition. They know added value equals a happy client. You can probably almost bet that one of the ways they are going to generate value is by doing everything they can to find data that points to working capital requirements that are higher than expected. They are highly motivated to provider the seller with all the ammunition they need to justify the last-minute price chip.

Do nothing means the owner of the rapidly expanding Christmas tree seller could find themselves suffering a price reduction late on in the process. For you the last-minute price reduction could mean a grumpy client who is not 100 per cent happy about writing out that cheque for your services.

We should be able to do better than ‘do nothing’.

What's the alternative strategy?

The alternative for the seller is to work to prepare themselves in advance of a potential argument. The seller could present a picture of ‘normalised working capital’ for the business and argue that any extraordinary fluctuations, e.g. two years ago, were one-off. This strategy sees the seller trying to get on the front foot and looking for an opportunity to present their own view of working capital.

Opportunities for the seller to present their own picture of working capital include:

1. The information memorandum (early in the process). This is a bit like a business plan, released early on to all bidders in the process. It is designed to contain all the information a potential buyer should need to bid for the business. The information could contain a broad overview of working capital requirements, but in practice release of detailed working capital requirements this early on is very rare.

2. Vendor due diligence. Here, the seller commissions their own accountants to provide a detailed picture of the business’ finances and releases this to short listed bidders. But accountants, like lawyers, are by nature thorough. Talk to any about conducting vendor due diligence and you will be amazed at what they feel they need to look at. And they don’t come cheap. And all of this work has to be done before the seller can even be sure they have a committed buyer for the business. And what the accountants may not tell you is that some buyers may discount the information contained in the vendor due diligence report anyway, given that it was prepared by the seller early on in the process.

3. A focused piece of work around working capital requirements. Alternatively, without commissioning a large piece of vendor due diligence, the seller could just ask his advisers or accountants to provide some supplementary information relating to the business’ working capital position, once the identity of short listed bidders is known.

4. Dataroom (late in the process). The seller could provide some information on working capital in the dataroom. This is relatively late on in the process when the buyer has his own accountants trawling through files of information on the business’ contracts and finances. Success here assumes that a number of buyers are proceeding through to this phase of the process (or at least waiting in the wings, eager to jump back into the process) and the seller is not already stuck with one bidder who is looking for any excuse to chip away at the price.

So, quite a few options. Alternatively, if there are some fly-by-night advisers reading this, and all of 1-4 sounds like too much trouble and work, there’s always the ‘do nothing’ option. The later it is left and the fewer buyers remaining in the process, the more likely it is that the seller could be forced to accept a price reduction from a buyer concerned about working capital. ‘Do nothing’ really does seem like a recipe for a last-minute price chip and a grumpy client!

What should the streetwise solicitor do?

Just a very few well chosen words could make all of the difference to how much your client appreciates your input.

Imagine you were the one person on the deal who was smart enough to check something with the client. Imagine early on you were sitting down with the client to map out the process and agree the scope of your work. Imagine the seller told you he had asked his accountants to amalgamate some information for the buyer’s accountants. Imagine you were smart enough to ask this question: “And what are you expecting the buyer’s accountants to discover about the working capital position for this rapidly expanding Christmas tree producer?” Think what an opportunity you could have to talk to them further and impress them.

Even if the conversation led nowhere, maybe working capital could, by some amazing fluke, become an issue in the sale of the rapidly expanding Christmas tree producer. Maybe your client vaguely remembers your thinly veiled warning about working capital. Maybe as the deal starts to drift south, suddenly you’re the one person your client is relying on (given that you perhaps were the only one to be smart enough to mention the issue early on). If your client is destined to become grumpy about the deal, surely it would be nice if they were least grumpy with you?

Hang on, isn’t working capital someone else’s job?

‘Yes’ and ‘no’. Worrying about working capital is far outside the formal job description for any solicitor. In an ideal world there would probably be a savvy accountant who had raised the same issue. But clients are sometimes slow to involve their accountants (after all, they’re almost as expensive as solicitors) and sometimes they’re brought in late working to a very tight budget, so are not that closely involved. In any case, accountants, like solicitors, are not all savvy.

So, it really depends how you see your job. Are you limiting yourself to the role of nit-picking drafter of documents (which, of course, does have value for your client)? Or are you the commercially focused streetwise solicitor, in touch with your client, speaking to them from the start, involved in the strategy for the process, making sure your position is absolutely cemented as ‘trusted adviser’ in your client’s eyes?

It’s your choice. You decide. At some point, if you find yourself advising the seller of a rapidly expanding Christmas tree producer, it could just help to check your client appreciates the potential impact of working capital.

Joanna Smith is a business development director at Financial Training Associates

Reprinted from Solicitors Journal

Law CPD: a new course for lawyers, accountants, solicitors and finance executives

Qualified solicitors and legal professionals are required to undertake CPD (continuous professional development). CPD requirements are determined by the SRA (Solicitors’ Regulation Authority), with the CPD year running to 31 October. Solicitors are encouraged to assume responsibility for their own development by choosing from a wide range activities relevant to their professional responsibilities and personal development. All solicitors who in legal practice or employment, or who work 32 hours or more per week, are required to complete a minimum of 16 hours’ CPD per year. At least 25 per cent of the requirement must be met by participating in courses that are offered by providers authorised by the SRA and which require attendance for one hour or more.

For more on law CPD points requirements click here:

· Law CPD

For more on CPD hours requirements for other professions, click here:

· CPD points.

Legal CPD course provider accredited for the legal profession

Financial Training Associates is accredited with the SRA as a CPD training provider for the legal profession. The company offers an extensive range of introductory, intermediate and specialist courses which can be delivered at a location to suit. Financial Training Associates' courses are regularly reviewed and revised to ensure they take account of latest developments, utilising experienced professional trainers who are experts in their field.

CPD training courses for solicitors

Financial Training Associates has developed a new CPD accredited course for lawyers titled: “negotiating the big issues in transaction agreements”. The course examines the commercial impact of key negotiations attached to company sales and acquisitions. The programme is designed as a forum where solicitors can comfortably practice debating the main value items in transactions.

Click here for more information regarding FTA's CPD training courses:

· CPD courses

CPD courses for law and accounting: negotiating big financial issues in Sale and Purchase (S&P) transaction agreements

Accredited CPD course provider FTA Ltd considers key points when negotiating one of the big issues for transactions: working capital.

Big issues for legal and other professionals: working capital

When purchasing a business a buyer might do all they can to identify financial data which enhances their position. As part of due diligence, the buyer’s accountants might use financial figures to argue that the target business has higher than expected working capital requirements.

Lawyers and other advisers: what’s the impact?

What’s the impact on negotiations? Put simply, identifying higher than expected working capital requirements gives the purchaser all the ammunition they need to try and reduce their asking price.

The buyer may argue that the seller has mis-represented the working capital requirements for the business. The buyer might argue that it is raising all the debt it possibly can as part of the purchase. The buyer has to keep some debt facilities in reserve to fund the unexpectedly high forecast working capital requirements.

With the new information, it appears that not all of the debt raised can be paid out to the seller. The seller is presented with a last minute price reduction: a last minute price “chip”. If the seller has been dealing exclusively with one buyer, and other potential buyers have left the process, the seller may feel they have little option but to accept.

The “big issues” CPD course

On FTA’s “Big Issues” seminar, delegates identify businesses with potentially low and potentially high working capital requirements: the ones where the working capital requirement might become a big issue.

Participants talk about the impact on negotiations, and break into groups to come up with a few suggestions for each side. Buyers will want to argue for high working capital requirements. What sources of information might be useful to them? What kind of time period should they look back over? What about looking forward?

Sellers know that a buyer could argue for high working capital requirements. How could a seller prepare for the debate? Is “do nothing” ever an option? What information could the seller helpfully release in advance? What different opportunities are provided during the process? What kind of buyers might the seller want to gravitate towards?

Accredited CPD training course provider FTA's “negotiating big issues” CPD course is designed to appeal to professionals working in law or accountancy, as well as other commercial managers responsible for negotiating transactions. While popular with The Law, this CPD course is regularly attended by a mix of participants from accounting, corporate finance, general advisory and commercial disciplines.

Click here for more information regarding FTA's CPD training courses:

· CPD courses

Financial Training Associates Gains CPD Accreditation

Financial Training Associates Ltd, a provider of courses to companies that wish to conduct financial training for small groups of employees, has now achieved accreditation with the Solicitors Regulation Authority (SRA). As a result, Lawyers can confidently use Financial Training Associates to help meet SRA requirements for continuous professional development (CPD).

Business Development Director, Joanna Smith commented: “The SRA reported back on our courses in great detail. Talk about glowing! We know our courses go down well with our current clients but we were delighted at the strength of the positive reaction from the SRA. It’s a great encouragement for all our staff and endorsement of what they do”.

The SRA’s report concludes with the assessor saying: “I have no hesitation in recommending this course”.

According to Mrs Smith, Financial Training Associates’ has established itself as a company providing finance training courses to institutions.

“Obviously our courses are well received by our existing clients, and we knew that members of the legal profession had already expressed in interest in what we teach, but we had never imagined that the SRA would respond so positively to our courses.”

For further details regarding Financial Training Associates’ accredited CPD course programme for the legal profession, please click on:

• CPD courses

Financial Training Associates Ltd: the Company

Financial Training Associates Ltd is a company that provides experienced finance trainers to clients who wish to run financial markets training courses for small groups of their employees. Courses encompass financial modelling training, corporate finance, company valuation, project finance as well as other related course subject areas such as risk management, corporate credit analysis, private equity, loan restructuring and energy risk management.

Financial modelling courses

Our financial modelling courses are all “hands on”. Delegates are provided with the opportunity to create their own cash flow forecast in Excel as part of building a complete and integrated model of financial statements from scratch. The focus is on learning by doing, with plenty of guidance and support provided along the way.

Corporate finance and company valuation courses

Our courses in these areas focus on the application of corporate finance and valuation techniques to real life problems. Although grounded in financial theory, the emphasis here is on “workshop style” teaching with pragmatic application to real life situations. For example, as part of their work, delegates work in teams to critique and suggest improvements to valuation work conducted by major investment banks.

Project finance courses

Our project finance courses encompass topics such as project risk and allocation, key performance indicators, major areas of negotiation, key contractual issues, due diligence, documentation, the impact and role of financing structures, as well as Excel modelling for project finance. Learning points on our project finance courses are regularly reinforced by referencing real life and well known case studies.

Risk management and corporate credit courses

Recent failures of risk control are too easy to find, to the point where it seems that no institution is immune. As a result, the role of risk management has changed: it is not just a mechanism of control but a critical component of business strategy. Our courses discuss recent control failures, outline alternative approaches to credit risk management, detail industry standard operational risk measurement techniques and explore the role of and pitfalls inherent in detailed risk modelling work.

About Financial Training Associates: our clients

Our clients include international financial institutions, major corporates and service providers such as accountants, lawyers and other advisers.

Useful and usable training courses

The finance training courses our trainers run are pragmatic, vocational and practical – designed to help delegates as soon as they return to their desks from training.

Specialised financial training courses

Our trainers are highly experienced individuals and bring skills equivalent to those of other senior people within, for example, top advisory firms.

Active learning

Our trainers work with energy and enthusiasm. Our trainers facilitate learning: interacting with their audiences, soliciting ideas from participants, running discussions and introducing up to date and relevant real-life case studies.

Financial Training Associates exists to match the very best trainers with clients who need specialist financial training courses in complex areas.

Financial Training Associates: Now Accredited for Providing Legal CPD Training Courses by the Solicitors Regulation Authority (SRA)

Financial Training Associates Ltd, a provider of finance training courses, has now achieved accreditation with the Solicitors Regulation Authority (SRA). As a result, Lawyers can confidently use Financial Training Associates to help meet SRA requirements for continuous professional development (CPD).

Business Development Director, Joanna Smith commented: “The SRA reported back on our courses in great detail. Talk about glowing! We know our courses go down well with our current clients but we were wonderfully surprised at the strength of the positive reaction from the SRA. It’s a great encouragement for all our staff and endorsement of what they do”.

According to the report from the SRA’s assessor:

- Course content “is clearly set out… maintains delegates’ interests and allows the material to be adapted to their specific needs”;

- Courses are “taught using a variety of methods, note-taking is encouraged and questions and discussions are actively encouraged with group exercises also being implemented…”; and

- Materials are “clearly organised… they are well-presented and will form an excellent aide memoir for delegates post-event… The materials easily cover the aims and intended learning outcomes… Delegates will benefit greatly… The materials are excellent, they are presented in such a manner which [indicates that the trainer] has a thorough knowledge/understanding of the work”.

The SRA’s report concludes with the assessor saying: “I have no hesitation in recommending this course”.

According to Mrs Smith, Financial Training Associates has established itself as a company providing finance training courses to institutions.

“Obviously our courses are well received by our existing clients, and we knew that members of the legal profession had already expressed in interest in what we teach, but we had never imagined that the SRA would respond so positively to our courses.”

For further details regarding Financial Training Associates’ accredited CPD course programme, please click on:

• CPD courses

Financial Modelling in Excel: How to Make Adjustments Upon Merger or Acquisition

The question: "How do I make adjustments in an excel financial model for a merger or acquisition?"

This post arises as a response to a question received by a financial modelling course delegate. Here we consider the main adjustments to a financial model when we are using Excel to analyse the acquisition of a business. These notes are high level and consider the relatively simplified case where a buyer is acquiring 100% of a target company.

Overview

Main changes that arise in the financial statements upon acquisition are:

• Profit & loss statement: adding the main operating line items of the target to the acquirer (e.g. revenue, EBITDA). Adding any synergies such as revenue increases, cost savings, cost increases e.g. restructuring costs. Adding increased financing costs arising for example through an increase in debt taken on fund the acquisition;
  
• Balance sheet: adding the main line items of the target to the acquirer. Adjusting for finance taken on to fund the acquisition e.g. an increase in debt. Adding “goodwill” that arises on acquisition. Goodwill is a type of intangible asset. It is a non cash accounting entry on the balance sheet. It represents the surplus of the price paid by the acquirer over the target’s net assets. Net assets equals the difference between total assets and liabilities on the balance sheet. It is also known as shareholders’ funds or shareholders’ equity.
  
• Cash flow: adding the cash impact of the adjustments above.

Modelling framework

Acquisition modelling involves building a financial statement for the acquiring business, building a model for the target business, and then combining the two models:

• Step 1: build a financial model for the acquiring business that separates inputs/ assumptions and financial statement calculations. For example, assumptions on one tab (tab 1a) and calculations for the p&l, balance sheet and cash flow on another tab (tab 1b);
  
• Step 2: next to the model for the acquiring business, build a similar model for the target business that includes adjustments upon acquisition in its assumptions (tab 2a) and runs these through a financial statement model for the acquisition target (tab 2b);
  
• Step 3: add the assumptions for the target and the acquirer (tab 3a; which equals tab 1a plus tab 2a). Run those combined tab 3a assumptions through a new financial statement model (tab 3b) for the merged business. Tab 3b yields the key results for the exercise: a full set of forecast financial statements for the merged business.

Building the model this way:

• Allows you independently to flex the assumptions for the acquirer and its target;
  
• Ensures that the changes in financing for the acquisition as well as changes in cash and debt balances, net interest expense, along with their interactions with the tax charge for the merged business, all flow through to the financial statements for the merged business at tab 3b.
  

Detail of modelling balance sheet adjustments

As outlined above (see the second bullet point under “Overview”) major adjustments to the balance sheet for the merged business involve:

• Adjusting for finance used for the acquisition (e.g. an increase in debt); and
  
• Adjusting for goodwill.
  

In this section we consider the detail of how you could accommodate these particular adjustments within a model:

• Step 4: build a “sources and uses” table within your model assumptions e.g. at tab 2a. Sources and uses sets out where all the funding for the transaction is coming from and what it is being used for. See the table below as an example. There is no completely standard way of presenting the detail of these tables and some judgement is required regarding the exact line items and how they are presented;
  
• Step 5: adjust the balance sheet assumptions for the target for the key items in the sources and uses table. Remember, key adjustments from the transaction are going to be around finance and goodwill. See the table below as an example. It walks through the exact steps (A-E) in careful detail.
  

Once you have separated the adjustments in this fashion, the assumptions at tab 2a will clearly show sources and uses of funds for the transaction. The adjustments will be built into opening balance sheet assumptions for tab 2a, feeding through into opening balance sheet assumptions at tab 3a and the financial statement forecast at tab 3b. Building in a balance sheet check (that total assets equals total liabilities including shareholders funds) will help you confirm you have made the adjustments correctly.

Financial Training Question: What is Debt Free Cash Free?

The question: what is debt free cash free?

Debt free cash free is the value of a business without any net debt (= debt less cash). Where a business has net debt, the debt free cash free value is higher than the value a seller would expect to receive for their shares in the business. Debt free cash free is very similar to another term used in finance: “Enterprise Value”.

For more information please see: "free CPD for law and accountancy".

For more detail of FTA Ltd’s CPD training courses that include coverage of this topic, please see www.cpd-courses.org.

Issues for Private Equity

The question: what are some of the big issues facing the Private Equity industry?

Editor’s note: this article was prepared by one of our trainers in response to a question received by a journalist who was surveying key issues facing the private equity industry. The answer draws on reports from the Financial Times, as well as our trainer’s industry contacts. For more information regarding FTA Ltd’s CPD courses that cover the private equity industry, please see http://www.cpd-courses.org/private-equity-and-company-buy-out.htm.

Background

Private equity is a subset of the funds management industry. Private equity firms draw down funds from their investors and use those funds to buy portfolio companies. The private equity firms charge investors a small % of funds under management but hope to make most of their money when portfolio companies are sold, splitting gains on sale with their investors.

The big threat for the sector is consolidation amongst private equity firms who can’t sell portfolio companies at a profit and attract new investors (who pay fees) in.

The private equity industry: past trends

Past features of the private equity industry, which have attracted public comment include:

1. High pay for private equity executives. Controversy over high pay outs for private equity executives, leading to an increase in the UK capital gains tax rate to 18% across all businesses, impacting more private business owners than private equity firms.

Reference: “Fund success leads to bumper pay-outs at CVC”, by Ellen Kelleher, Financial Times. Published Oct 15, 2007.

Private Equity executives have made their money by capturing a share of the upside when they sell portfolio companies at a profit. Reference: “Private equity investors: The bosses, the takeovers and the dividends”, by Martin Arnold, Financial Times. Published October 31 2007.

2. Union pressure. Private Equity executives were under pressure from unions for the changes they make when they restructure portfolio companies. The heat has died down a bit for them since we have all had the credit crunch to worry about!

Reference: “The bashful buy-out king”, by Peter Smith, Financial Times. Published: Apr 24, 2007.

3. A lot of debt. Pre credit crunch, high levels of debt were being used to fund purchases of portfolio companies. Now private equity firms can’t purchase companies with as much debt as they could, and this has some severe implications (see points 6-8 below).

Reference: “Overheated private equity market suggests trouble ahead”, by Martin Arhold, Financial Times. Published: Oct 5, 2007.

The private equity industry: recent trends

More recent trends for the private equity industry include:

4. Debt write offs. Write downs in the valuations of loans, much originating from private equity buy outs, tempting distressed debt buyers into the market. They see an opportunity to make their investments at reduced values. One of the criticisms banks have faced is that they lent too much money to private equity portfolio companies.

Reference: “Banks tempt 'vulture funds' to shift $200bn LBO backlog”, by James Mackintosh, Financial Times. Published October 5 2007.

5. Stuck with high debts. Private equity portfolio companies, with high levels of debt and unable to sell themselves at a high value, are likely to face difficulties refinancing their existing debt.

The level of debt being supplied by banks is very low, despite the extent of government support they have received. Pre-credit crunch principals could raise anything up to 10x for the biggest buy outs, sometimes more. Now, for mid-market deals, it is down to around 3-5x EBITDA, less for smaller deals. Anything beyond that is a stretch for banks, so little debt is available to fund buy outs.

Reference: “Private equity faces refinancing headache after era of easy money”, by Henny Sender, Financial Times. Published: March 18 2009.

6. Stuck with portfolio companies. Private equity firms are having trouble selling their businesses at high values, partly because banks won’t lend the money to the purchasers.

Banks are dancing with fewer and fewer partners. Banks are, unofficially, limiting who they provide finance to. Banks are so short of finance that they’re choosing to work with people they have backed before, so as to preserve those relationships. Banks are not advertising this but, according to industry insiders, it does seem to be the case. This makes it very hard for someone who needs finance to get it, because the number of potential banks they can turn to is limited to those they have worked with before.

Pre credit crunch private equity firms used to drag a couple of banks into the room for meetings with potential vendors. One or none of those bankers would expect to get the deal but they would all play the game because they were so desperate for the business. Now the boot is firmly on the other foot. The challenge for private equity is just getting one banker committed when vendors are very wary of a potential buyer who can’t demonstrate that they can get bank finance in place.

So we’ve got banks supplying a reduced amount of available finance. At the same time valuations of portfolio companies are plummeting and private equity firms are having to book the losses.

Reference: “Private equity exits plummet”, by Martin Arnold, Financial Times. Published March 25 2009.

Reference: “European buy-out funds left bruised”, by Martin Arnold, Financial Times. Published April 15 2009.

7. Forecasts for a cull in private equity firms. If they can’t get exits and make profits, private equity firms can’t attract new investors in (who pay them management fees and bonuses) and they’re out of business.

Reference: “Buy-out bosses warn of private equity cull as 'tourists' quit”, by Martin Arnold, Financial Times. Published: March 16 2009.

Reference: “Candover assures it can meet debt covenants”, by Martin Arnold, Financial Times. Published: June 2 2009.

8. Investors taking flight. Private equity’s funds are at risk of evaporating, as investors put less money into private equity funds.

Reference: “Permira hopes fund move will appease investors”, by Martin Arnold and Henny Sender, Financial Times. Published: December 7 2008

Reference: “Investors steer clear of private equity funds”, by Martin Arnold, Financial Times. Published: April 2 2009.

9. Increased regulation. The private equity industry, post credit crunch, is seeing the threat of more regulation imposed on it from Europe. This seems a bit harsh if you take the view that the industry has been a victim, rather than a cause, of the credit crisis. Most commentators would have thought regulation might be targeted at banks before private equity firms.

As mentioned at the top of this article, the big threat for the sector is consolidation amongst private equity firms who can’t sell their portfolio companies at a profit and attract new fee-paying investors in.

The private equity industry: opportunities

Opportunities in the sector are there for:

- Private equity firms that do have cash to invest (now should be a good time to buy assets);

- Specialist private equity firms that invest in stressed businesses;

- Specialist investors in distressed debt. They have the opportunity to buy debt at a low face value and then sell on at a profit later;

- Specialist investors who purchase private equity companies’ portfolios wholesale;

- Advisors who can help private equity firms refinance debt as well as crunch their businesses or portfolios together to deliver savings.

In short, the industry is facing outrageously difficult times but there are always opportunities for someone!

About financialtrainingassociates.com: the company

Financial training company financialtrainingassociates.com runs CPD courses in private equity buy outs and other topics such as Excel modelling, valuation and corporate finance.

An Article on Mezzanine Finance from Financial Training Associates

The question: please can you tell me something about mezzanine finance?

This question arose on a course in debt structuring, conducted by one of our trainers, for Spain's largest bank. Please see the company’s website for full details of our financial training courses.

Here are some points on mezzanine finance:

1. Mezzanine is expensive

The first point I make about Mezzanine is that it is expensive. Whereas a bank lending to a levered deal could want a margin of say around 3% above base, as an order-of-magnitude comparison, a mezzanine provider might be looking for a total return of around base plus 10%. This makes it an expensive product and a finance director in a buy out would only want to use a little of it.

2. Mezzanine can enhance returns

Mezzanine is risky for the provider (they rank behind other creditors) and they're going to price it highly, making it expensive for the company. So why use it at all? The answer is that it can still enhance equity returns. Imagine a private equity investor purchasing a business for 100m, contributing 20m of its own equity and raising the 80m balance from the bank (in the good old days - when debt was more freely available!). When selling 5 years later say for 140m, the private equity firm would pay off the 80m debt, leaving 60m equity proceeds and enabling it to have tripled its 20m equity investment (3x money multiple).

Alternatively, if the private equity firm were able to get just a little bit more debt into the deal, e.g. from a mezzanine provider, its returns could be further enhanced. For example, imagine that the private equity firm raised a further 10m in mezzanine meaning the business purchase was funded 80m debt, 10m mezzanine and 10m equity from the private equity firm. When selling for 140m, the private equity firm would pay off the 80m debt, pay off the 10m mezzanine making equity proceeds 50m. With a bit of extra debt from the mezzanine provider, equity out = 50m, equity in = 10m and the money multiple has gone up from 3x to 5x - which represents a huge increase in return.

Although mezzanine can be used to reduce the size of the initial equity investment and enhance returns as described above, it could also be used to pay more for the business (and perhaps win the auction process to purchase the asset and earn the M&A adviser his fee). So - there are good and bad reasons for using mezzanine. The good reason for using mezzanine is to enhance returns. The bad reason is to pay more for the business!

3. The terms of mezzanine are highly variable

Although the mezzanine provider will be looking for a high return for providing finance via this risky product, the actual terms of mezzanine are highly variable and subject to negotiation. Some of the mezzanine provider's return will be received as interest, and some would be received as equity upside. For example, when/ if the business is sold at a price above a certain level, then the mezzanine provider receives a share of that upside, just like a regular equity investor would. The equity upside can be implemented in a number of ways but often it would be implemented through share options or warrants (= company issued share options) or it could be implemented as a straight purchase of shares in the buy out.

The split between interest and equity upside is variable but, from the mezzanine provider's perspective, biasing his return towards the equity upside will mean he has to wait longer to get his return, and so it may make him want to charge a higher overall return (i.e. it's not going to encourage him to reduce his say base + 10% target return figure).

4. Rolled up interest is often a feature of mezzanine

Although a mezzanine provider might expect to get some interest along the way, because the deal will be highly levered, it is unlikely that the buy out will be able to afford to pay much interest along the way. As well as a negotiation over the split between interest and equity upside, one of the key negotiations around mezzanine is how much interest is paid along the way and how much is rolled up i.e. accumulates and is paid out later. Interest that is rolled up and paid out later is called "PIK" or "Payment In Kind". In fact, you can get a pure PIK instrument where the provider waits until maturity to receive rolled up interest as well as return of principal.

5. Lots of scope for negotiation

So, lots of negotiation to be had around Mezzanine:

- Over the total acceptable return (e.g. base + 10%);

- Over how much equity upside the mezzanine provider receives (i.e. how long it has to wait for its

return); and

- Over how much interest is paid along the way v.s. how much accumulates.

6. The senior lender's perspective

We can understand why the private equity firm and the buy out's management team might be in favour of using a little bit of mezzanine to enhance returns, but how is the senior debt provider thinking about things? The senior debt provider may be worried that an aggressive adviser has used mezzanine to pay the highest price to the previous owner of the business, allowing the advisor to walk away with a big fee. The senior debt provider, after hearing that mezzanine is involved, may start worrying that his clients are paying a bit too much for the business and that the whole deal is in danger of quickly falling into bankruptcy post buy out.

Although the senior debt holder ranks ahead of other finance providers, he still doesn't want to be involved in a structure where the mezzanine provider can exercise conditions of default. So, rather than relaxing because he is first ranking a senior debt provider, having found out mezzanine is involved the senior debt provider is going to want to understand:

- The conditions under which default can be exercised (the senior debt holder is unlikely to want to find himself in a liquidation situation, even if he expects to get repaid);

- Whether the business can afford to meet its total debt repayments (how much of the interest on the mezzanine rolls up and how much has to be paid along the way); and

- What happens to surplus cash in a good year (the senior debt provider may want cash retained in the business whereas the company may want to pay off some of its mezzanine or at least the accumulated interest on mezzanine).

For a senior banker, finding out that mezzanine is being used in a buy out structure is not necessarily a great thing! It's certainly not likely to increase his appetite to lend into the situation!

7. Summarising mezzanine

How can we summarise mezzanine?

- A little bit can be useful to enhance returns;

- It's expensive so buy outs shouldn't want to use a lot of it;

- It's risky - high interest costs mean that, unless the business grows strongly, it may have difficulty re-financing its mezzanine.

Many buy outs will get financed on a combination of A senior debt (amortising over say 5-10 years) with a small amount of B senior debt (repaid in one lump sum, or a bullet, after the A is repaid). Occasionally mezzanine will be used but it carries risks for the company and is also risky for the provider. It's not suitable for all deals (strong growth is required to ensure it will be repaid) and these days, it's not as easy as it used to be to find someone who will tell you they have an open cheque book when it comes to providing Mezzanine!

About financialtrainingassociates.com: the company

Financial training company financialtrainingassociates.com runs finance-related courses in debt structuring, banking, Excel modelling, project and corporate finance, valuation and related subjects.