Private equity auctions have been a recurring theme in the deals market of the past 12 months. Once the preserve of the top end of the market, the £3100m-plus deals, they have become an increasingly prevalent feature of lower value transactions, down to £320m-turnover companies and lower. I choose my words carefully. Auctions are certainly more prevalent. They are definitely not more popular, at least, not among the private equity houses, which are usually the parties doing most of the bidding.
The theory is that running an auction ensures that the vendor receives the maximum price for its business. It works like this: advisers ensure the business is perfectly primed for sale. They undertake thorough research to identify the likely buyers, ideally a maximum of around half a dozen."If you do your research properly, you should be able to identify the five or six most likely bidders fairly easily. You look at who has other investee companies in that sector, who has good contacts within a similar customer base, who is invested in synergistic companies, who has done similar deals before, these are the sorts of things you should be looking at in terms of targeting the likely bidders and ensuring the maximum price," says Craig Hopwood, senior investment manager at Aberdeen Asset Management Private Equity.
Information memoranda are then sent out to these targets (or their advisers) containing basic information about the business, its strategy and its finances. Interested parties submit bids for the business by a specified date, with the lowest bidders ruled out at each round. The highest bidders, perhaps two or three, then submit second round bids. The bidding continues until only one bidder remains. That bidder gets exclusivity on the deal. In effect, that means that they alone go forward to begin more in depth discussions with the vendor and gain access to much more detailed information on the business, before completing the deal at the winning bid price.
The process is open to abuse, however. While a tight auction will focus on five or six likely buyers, it is not uncommon for auctions to involve 25 or 30 parties, only some of whom have a realistic interest or chance of success. With each bidder having its own team of advisers and lawyers working on their bid, it can be time consuming and expensive process, with a limited chance of success. The result is that some private equity houses are actually put off from the auction, rather than encouraged to bid.
"Poorly targeted auctions involving an excessive number of bidders can be an expensive waste of time, with none of the advisors, funders, or vendors benefiting from the experience. They can potentially frustrate the sale process and ultimately depress the asset price," says Carl Wormald, a director at LDC.
Nor does an auction guarantee the best price for the business. The auction process usually imposes strict controls on the timing of bids and the subsequent deal process. This can put off some buyers, usually trade buyers, who tend to be more cautious and can't move quickly enough to meet the auction timetable.
One tactic, which is commonly used by winning bidders, and is guaranteed to cause rumblings among the auction losers, is to bid high purely to gain exclusivity on the deal, with the explicit aim of then chipping the price back down to a more acceptable level once you have full disclosure of the deal documentation.
In the recent auction for Bargain Booze, for example, the winning bid by ECI reportedly began with a seven. Indeed, when the sale story first broke the figure quoted was £370m. But the final deal completed at £363.5m - allegedly not too far from the earlier bids of the losing parties. It is a cunning tactic and one that all private equity houses use. But it's not one that shows auctions in their best light.
Tim Hamilton, corporate finance partner at Addleshaw Goddard, says: "There's definitely a question mark over whether the auction process leads to a better price or is simply an over-transparent process. I would be interested to see how many times the price offered at the point of exclusivity is the price actually paid, and the extent to which the ultimate price is still an improvement on the true market value. And if it is over the market value, then unless the bidder has a particular angle, it just stores up trouble for the future."Private equity auctions have been a recurring theme in the deals market of the past 12 months. Once the preserve of the top end of the market, the \xc2£3100m-plus deals, they have become an increasingly prevalent feature of lower value transactions, down to \xc2£320m-turnover companies and lower. I choose my words carefully. Auctions are certainly more prevalent. They are definitely not more popular, at least, not among the private equity houses, which are usually the parties doing most of the bidding.
The theory is that running an auction ensures that the vendor receives the maximum price for its business. It works like this: advisers ensure the business is perfectly primed for sale. They undertake thorough research to identify the likely buyers, ideally a maximum of around half a dozen.
"If you do your research properly, you should be able to identify the five or six most likely bidders fairly easily. You look at who has other investee companies in that sector, who has good contacts within a similar customer base, who is invested in synergistic companies, who has done similar deals before, these are the sorts of things you should be looking at in terms of targeting the likely bidders and ensuring the maximum price," says Craig Hopwood, senior investment manager at Aberdeen Asset Management Private Equity.
Information memoranda are then sent out to these targets (or their advisers) containing basic information about the business, its strategy and its finances. Interested parties submit bids for the business by a specified date, with the lowest bidders ruled out at each round. The highest bidders, perhaps two or three, then submit second round bids. The bidding continues until only one bidder remains. That bidder gets exclusivity on the deal. In effect, that means that they alone go forward to begin more in depth discussions with the vendor and gain access to much more detailed information on the business, before completing the deal at the winning bid price.
The process is open to abuse, however. While a tight auction will focus on five or six likely buyers, it is not uncommon for auctions to involve 25 or 30 parties, only some of whom have a realistic interest or chance of success. With each bidder having its own team of advisers and lawyers working on their bid, it can be time consuming and expensive process, with a limited chance of success. The result is that some private equity houses are actually put off from the auction, rather than encouraged to bid.
"Poorly targeted auctions involving an excessive number of bidders can be an expensive waste of time, with none of the advisors, funders, or vendors benefiting from the experience. They can potentially frustrate the sale process and ultimately depress the asset price." says Carl Wormald, a director at LDC.
Nor does an auction guarantee the best price for the business. The auction process usually imposes strict controls on the timing of bids and the subsequent deal process. This can put off some buyers, usually trade buyers, who tend to be more cautious and can't move quickly enough to meet the auction timetable.
One tactic, which is commonly used by winning bidders, and is guaranteed to cause rumblings among the auction losers, is to bid high purely to gain exclusivity on the deal, with the explicit aim of then chipping the price back down to a more acceptable level once you have full disclosure of the deal documentation.
In the recent auction for Bargain Booze, for example, the winning bid by ECI reportedly began with a seven. Indeed, when the sale story first broke the figure quoted was £370m. But the final deal completed at £363.5m - allegedly not too far from the earlier bids of the losing parties. It is a cunning tactic and one that all private equity houses use. But it's not one that shows auctions in their best light.
Tim Hamilton, corporate finance partner at Addleshaw Goddard, says: "There's definitely a question mark over whether the auction process leads to a better price or is simply an over-transparent process. I would be interested to see how many times the price offered at the point of exclusivity is the price actually paid, and the extent to which the ultimate price is still an improvement on the true market value. And if it is over the market value, then unless the bidder has a particular angle, it just stores up trouble for the future."