There has been a significant rise in search fund market activity in the UK and Europe, both in deal volumes and average deal size. This has been driven by a combination of factors:
Strong supply side dynamics with challenges in succession planning faced by many family-owned SME’s.
Growing recognition of search funds as a distinct and attractive asset class among investors.
The potential for appealing, risk-adjusted returns through the acquisition of sustainable, cash-generating businesses.
An increasing willingness from funders to support search fund transactions.
However, for searchers, the process remains demanding, requiring persistence and commitment to successfully close a deal. This involves identifying the right target, building trust with the seller, negotiating the purchase price and deal structure, conducting due diligence, securing debt financing, managing the flow of information, coordinating communication between sellers, investors, and funders, and navigating the legal and documentation processes.
View of the Lender
Inicio have experience of working on both sides of a transaction, as lender and advisor on search fund deals, which gives us a detailed understanding of the various moving parts and managing execution risk. There are certain characteristics of this type of proposal that influence a lenders risk assessment and debt structures will be bespoke to the transaction.
Corporate or Financial Sponsor
Lenders will differentiate between owner managed businesses and private equity backed transactions and may have separate and defined credit routes and appetite for each.
An equity cheque from professional investors with governance controls will be looked on positively.
If no significant equity, lenders will look to gain comfort on track record and ability to provide follow-on capital if required.
While growing, this remains an emerging asset class and lenders will analyse and diligence as appropriate to address their own internal stakeholders’ requirements.
Management Buy-In
Key difference from more traditional MBO’s is that searchers will typically take on a senior operational role in the business as opposed to a financial sponsor backing an existing management team.
Lenders may look at this as having management buy-in risk attaching and can limit credit appetite.
In view of these characteristics, it is critical to i) cover all the bases when preparing to approach lenders and ii) ensure the right lenders are approached at the outset – this will maximise the chance of success and obtaining the most competitive funding terms. Mosty lenders will look to be provided with external financial due diligence and depending on the type of business perhaps commercial due diligence.
Key Areas of Focus
In order to mitigate perceived credit risks in a search fund transaction, there are some key aspects that we would consider important.
Structural: An element of vendor deferred consideration will be a common component of the capital structure. Vendor can also be incentivised by way of an equity rollover and/or combined with a performance linked earn-out. Lenders will look for this to be fully subordinated with any cash payment of interest or capital subject to ongoing financial covenant compliance; providing comfort that there is downside protection on cashflows and indicative that vendor has belief in the future performance in the business.
Searcher: very much a key focus for lenders with specific focus on: –
Deep and detailed knowledge of the target business and the industry in which it operates; previous experience of working in the sector is advantageous.
Depending on senior role the searcher will assume, past experience operating in a role of that nature.
Strong understanding of the strategic goals and value creation opportunities.
Excellent communication and leadership skills to lead the business with confidence post-completion.
Demonstration of commitment through personal cash equity injected in the structure, lenders will want to see ‘skin in the game’.
2nd tier management: A strong and loyal incumbent 2nd tier management team who are operationally involved in day-to-day running of the business will assist in mitigating the perceived MBI risk. Appropriate incentivisation measures will be expected to be in place to ensure all parties are aligned.
Quality of security: Lenders will look to ensure that they are structuring and pricing the transaction reflective of the risks involved and will analyse the security package, equity cushion, and valuation metrics both at entry and exit.
Inicio's Role
Searchers will look at sourcing a target and raising equity as critical milestones, however, to reduce execution risk we would recommend that preparation for approaching the debt markets is undertaken as early in the process as possible.
Our role in supporting search fund transactions varies depending on the proposed acquisition terms and experience of the searcher. Primary focus is to determine, structure and arrange appropriate debt facilities whilst minimising execution risk. This will include ensuring that structural terms and covenants are negotiated as appropriate in order to maximise headroom and protect both searcher and investor against any unforeseen events that may arise during the course of the loan facility.
Inicio’s role can also include collaborating with searcher in preparation of a fully integrated model with sensitivity analysis, supporting through due diligence and legal process, and project management of completion mechanisms.
How we work
At Inicio Corporate Finance, our expert team leverages decades of UK and global experience through our looped international relationships and M&A network. With strong relationships across Europe, Asia, North and South America, we offer a global perspective tailored to meet the unique needs of SMEs.
At the core of what we do is building long-term, trusted relationships.
We act as strategic partners, guiding companies through the intricate processes involved in achieving their financial goals.
We do not issue engagement terms until we completely understand your objectives, and we are confident that we can help and add value. This can take weeks, months, and in some cases, years.
To find out more please contact Scott Taylor at [email protected] or Kenny Hughes at [email protected]
