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November 2017

Funding for growth

Best Managed Companies Breakfast Session

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© 2017 Deloitte. All rights reserved

Time Agenda Speaker

8:25 Introduction Anya Cummins, Head of M&A, Deloitte

8:30 Funding Market & Options John DoddyHead of Debt & Capital Advisory, Deloitte

8:45 Assessing Debt Markets David MartinDirector, Debt & Capital Advisory, Deloitte

9:00 Raising Equity for Trading Business Anya Cummins, Head of M&A, Deloitte

9:15 Structuring for Funding David Shanahan Partner, Tax and Legal, Deloitte

9:30 Keynote Speaker Justin Keatinge Co – Founder of Version 1

Agenda

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Funding Market & OptionsJohn Doddy – Head of Debt & Capital Advisory, Deloitte

4© 2017 Deloitte. All rights reserved

Current Funding Market in Ireland and Global Trends

Funding Market and Options


Identifying the appropriate form of capital for you business


Equity

• No obligation to repay• No default risk for

borrower but potential loss for equity provider

• Dilution of shareholding

Debt

• Obligation to repay• Obligation default risk

• No dilution of shareholding VS

Continued pressure for funds to deploy capital is resulting in an increasing convergence between debt and equity.

Traditionally turned to private equity when looking to raise capital alternative strategies are now offering an increasing number

of non- controlling, less dilutive options to corporates.


Identifying the appropriate form of capital for you business


“Scale attracts capital”

Capital > €100m

EBITDA > €20m

Large Corporates

Capital: €10m - €100m

EBITDA: €2m - €20m

Mid Corporates

Capital < €10m EBITDA < €2m

SME’s

Institutional Private Equity

High Net Worth Equity

Traditional Lenders

Alternative Lenders

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Accessing Debt MarketsDavid Martin, Director, Debt & Capital Advisory, Deloitte


Accessing the appropriate level and type of debt

Accessing the Debt Markets

Structures

EV/EBITDA

0x

1x

2x

3x

4x

5x

6x

7x

8x

9x

10x

Unlevered Leveraged Unitranche Senior/Mezz

Up to 3x

Senior debt

E + 50 –

350bps

3x-4x Senior

debt

E + 300-450bps

4x- 5x

Unitranche

E + 650-900bps

Weighted Average Cost of Debt (WACD)

E + 50-350bps E + c.450bps E + c.750bps

Pros and Cons per structure

Senior debt (Bank)

Unitranche / Mezz (Fund)

Equity

Note: the structures and

pricing presented are

indicative and only for

illustrative purposes

1x - 1.5x Mezz

E + 1200bps

3x-4x Senior

debt

E + 300-450bps

E + c.750bps

Lowest pricing

Relationship bank

Bullet RCF

Increased leverage

Club of relationship

banks

Stretched leverage

Flexible covenants

Speed of execution

Relationship lender

Low level of

amortisation

Low leverage

Shorter tenor (3-5

years)

Leverage not as high as

other structures

More restrictive terms

Amortising

Higher pricing

Non call periods

Stretched leverage

Flexible covenants

Greater role for

bank

Higher pricing

Intercreditor/AAL

High Growth options


How to run a debt raising process


Information Memorandum

Financial Model

Competitive Process

Due Diligence

Funding Terms

Completion

“Before anything else, preparation is the key to success”

Alexander Graham Bell

Information Memorandum containing:

• Overview of the business • Historic financial information• Financial projections – cashflows most

important• Management team information• Funding requirement

• Identify the relevant funders

• Manage a dataroom• Preparation for due diligence• Manage the due diligence

process

• Consider the appropriateness of funding terms – covenants, conditions precedent, dividend restrictions etc.

• Manage the process to completion

• Ensure the documentation reflects the commercially agreed terms


What debt funders are looking for and why


- Historical Quality of Earnings

- Revenue and Cash Flow Visibility

- Cash Flow and Cash Conversion

- Debt Service Cover

Financials

- Strong Customer Base

- Margins

- Client Concentration Repeat Business

Business Overview

- Appropriate Level of Refinance Risk

- Matching Assets to Liabilities

- Asset Cover

Risk

Competent Management

Team

Raising Equity for Trading

Business

Anya Cummins, Head of M&A, Deloitte


What type of funding options are available to you and your business?

Equity options

Venture capital

Venture capital is financing that investors provide to start-up companies and small businesses that are believed to have long-term growth potential.

Typically early stage and mainly focused on the tech sector.

High net worth individuals

Represent a small number of individuals with disposable capital who will generally invest directly in your business or through a 100% owned holding company.

Employment & Investment Incentive Scheme (EIIS)

EIIS allows individuals to obtain income tax relief on investments in qualifying SMEs. These investments are generally small in nature given the per person annual limit of €150k. Crowd funding also emerging as an alternative.

Private equity

Private equity represents the largest potential private funding source in the Irish market for SMEs which can be utilized to fund new technology, make acquisitions, expand working capital, and to bolster and solidify a balance sheet.


The Irish private equity market is highly competitive with multiple funds offering flexible solutions to SMEs

Private equity providers

FundInvestment

rangeStake

Investment instruments

€2 - €10m Minority Flexible instruments

€2 - €12mMinority / Majority

Equity / Loans

€1 - €10mSignificant minority

Equity / Loans

€5 - €50m Majority Equity

€1 - €3m Majority Equity / Debt

€2.5 - €10m Majority Equity

€2 - €10m Minority Equity / Loans

Minority stake

Majority stake

Equity instruments

Equity / quasi equity instruments

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Attracting international investment


Ireland continues to be an attractive destination for international investment


Irish companies continue to attract interest from

global PE investors with

18 transactions worth

€7.5bn in the first 6 months of 2017 representing the highest H1 figure on Mergermarket record

Irish businesses by definition are export focused with Irish exports

increasing c. €28bn between 2010 and 2016 - this represents an

attractive proposition for international funds. Brexit is also driving increased inward investment.

Global PE investors continue to target Irish companies in the

TMT sector in particular representing

15% of total dealsmade in H1

BUT we are seeing continued strong activity across a range of other business sectors including business services, consumer, F&B, healthcare and industrials


Some examples of foreign PE investment in Irish businesses


US headquartered JMI Equity and JMI Services invested in 2016

US based Spectrum Equity invested c. €26m in September 2017

UK based Synova Capital invested along side US based Five W Capital in

September 2015

UK Private Equity firm ECI Partners invested c. €40m - €50m in 2011

UK based Exponent Private Equity acquired Fintrax for €170m in 2012

UK based Mayfair Equity Partners invested in Promise Gluten Free in 2017

Recent PE bidders or actively pursuing processes in Ireland

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Introduction to Private Equity


What is Private Equity?


Private Equity is an “Investment club” generally

seeking capital profits through investments in a

portfolio of private companies which are often

supported by bank debt

Key objectives of any private equity fund investment

is to make a return and create value within its

portfolio companies (increasing shareholder value)

Private equity fund managers are actively involved

in raising funds from investors, sourcing

investment opportunities, negotiating deals and

actively managing investments with a view to

realising returns

Carried interest

scheme

General

partner

Investment

Manager

PE Fund

Investment

A

Investment

B

Investment

C

Investment

D

Investment

Fund A

Investment

Fund B

Investment

Fund C

Investment

Fund Z

Partners in PE

fund

Capital gains, dividends and interest (C,G,D&I)

Fee income

CG

D&

I

CGD&I

Typical Private Equity Structure

All PE funds are very different – all seeking a

competitive advantage in the marketplace whether

it be Venture Capital, Growth Capital or Private

Equity.


Buy & Build• Potential to deploy further capital to

fund a buy and build strategy• Organic versus acquisition

internationalisation• Outward looking, potential to

operate competitively in a myriad of countries

Management team

• Strong team committed to the future of the business

• Consider shareholder objectives and rollover

• Consider board composition• Dynamic management team with

wealth of experience

Underlying sector• Significant PE interest in certain

sectors – where there is strong deal activity and successful exits

• Attractive potential returns – mid 20% IRRs and money multiple returns of 3x plus (typically over 3 to 5 years)

• Market opportunity: New technology or new regulations provide market opportunities

• Market leader or opportunity to become market leader (even in a specific niche) often a key attraction

Financial performance• Recurring revenues and quality of

earnings – highly attractive (lumpy project revenue can be more difficult)

• Track record of achieving budget• Appropriate Leverage (definition of

appropriate is wide!)• Cash conversion (capex, working

capital)• Financial track record and attractive

level of profitability of the business• Growth forecast presented – exciting

business plan that is deliverable and delivers PE target returns

• Progressive product growth and new product development culture

• Defensible market position

Market share

The attractiveness of a business to PE?



A typical deal structure


Interest payments

Private Equity House

BidCo

Target Management team Rollover/ Sweet Equity

Target Company

Bank

MidCo

TopCoLoan Notes

Interest payments

Bank Loan

Back to back loan

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A transaction with a private equity house will often involve a partial sale as management shareholders will typically reinvest a proportion of their sales proceeds, into the acquiring company.

Equity/Sweet equity shares are typically only issued to management teams in a leveraged buyout (LBO) involving a PE partner.

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Private equity houses raise funds and manage these finances to yield favourable returns for their shareholder clients, typically with an investment horizon between four and seven years.

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3

A private equity transaction will generally involve an element of bank debt to enhance the returns of the private equity house.

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Enterprise value (EV)of a Oldco (target company) is generally derived from a

multiple of EBITDA

Valuation of Oldco and Newco funding considerations


or

EV is adjusted to reflect

net debt andtarget working capital levels

Equity valuerepresents the value of the

Oldco (target company) to current shareholders

Level of leverage

Management rollover %

Sweet equity

Private equity cheque size

Newco funding considerations


PE companies thrive on completing transactions and therefore demand information to be comprehensive and consistent


Fully populated data room Preparation of a well thought out data room will not just simply provide information on the key diligence areas but will bring confidence in the underlying business functions

Full Vendor Due Diligence completedInvestment in diligence prior to beginning a process is key to highlighting areas of focus for you and allows for lighter diligence by potential investors

Complete financial modelThe financial model will form the basis of

any investment decision and a well thought out and flexible model will be

crucial to an expedited and successful transaction

IM reconciling to all financials

As the IM forms the basis of the initial decision to progress a transaction it is key that all the information included reconciles

to the underlying data when diligence as any surprises will slow the process

Aligned shareholders with a full understanding of those rolling shares and the proportion being rolled


Where do businesses generally fall down on diligence? – Preparation is key


Normalised EBITDA

Net working capital

Net debt and debt like items

Area of focus Issues that arise

Net debt is an adjustment to the value (and surplus cash is extracted). Issues that come up include committed capital expenditures and potential liabilities which have been excluded from the calculation of net debt and have a major value impact.

Certain non-recurring/non-cash items have been considered in the calculation of normalised EBITDA or underlying profit presented doesn’t stack up to diligence (misstated, loss of key clients etc)

Items which would not meet the definition of working capital have been included in the target working capital calculations. NWC ultimately becomes a price adjustment and in some cases can be relatively material to the overall transaction structure.

Projections

Growth rates applied in the projections do not tally against the commercial due diligence and historical budgeting has lacked accuracy, business tracks behind budget or the projections not exciting enough/don’t deliver PE target returns.

Funding requirements

Ongoing cash generation of the business is volatile due to capex and significant working capital requirements. Cash conversion is a key metric for PE.

Impact

Net debt is understated and the adjustment will have a negative impact on the equity value of the business to shareholders. Planning in the deal structure for the extraction of surplus cash in a tax efficient manner.

The initial Enterprise Value of the business was overstated and stakeholders will have to reassess their valuation expectations. Often arises where the business falls behind budget during DD…..

The difference in will impact the equity value of the business to shareholders and potential investors. Early presentation of a robust vendor friendly position can be very favourable for the shareholders. Working capital management well in advance of the transaction.

Confidence in the projected numbers is eroded and could significantly impact the outcome of the transaction.

Inability of the business to generate a consistent cash flow will concern potential investors and may impact the outcome of the transaction

Management structure

Current corporate and reporting structures are not fit for purpose and there may be succession issues. Sole dependency on a single entrepreneur. Gaps in senior management team. Board.

Potential investors may not wish to invest if the operational structures in place are inefficient and overly reliant on a small number of individuals. Succession a key focus.

Management retention

There are no formal retention policies in place for senior management / management not incentivised.

Sweet equity will typically form part of the deal structure. Consideration of level of cash out and rollover.


Best Managed Companies ProgrammeTax Structuring for funding

David Shanahan – Tax Partner – Deloitte

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Key tax considerations

• How should we structure debt funding?

• Pitfalls in loan agreements

• What should we be doing now to prepare for new debt/equity?

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Borrower alternativesBroadly 2 options for debt structuring as follows:

1.Obtain funding directly into a trading/rental company

2.Obtain funding into a holding company and then

• Lend down to existing subsidiary

• Subscribe for equity in existing subsidiary

• Use funds to acquire shares

• Refinance existing debt

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Option 1: Direct funding into Trading/Rental Co• Usually straightforward

• Interest payable is generally allowed as a corporate taxdeduction against trading/rental income

• 20% withholding tax in principle but generally not an issue dueto a range of withholding tax exemptions e.g. payment to banks.

• Interest on refinancing existing trading/rental loan also qualifiesfor tax deduction

• Deduction is on accruals basis

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Option 2: Funding into a Holding Co• More complicated

• Tax deduction for interest actually paid is only allowed in certain circumstances.

• Range of qualifying conditions, including:

Funds must be used to acquire shares or lend to a connected company or subscribe for equity;

The holding company must hold more than 5% of the ordinary share capital in the company at the time the interest is paid;

The 2 companies must have at least one common director;

Considerable anti-avoidance legislation, incl. recovery of capital limitations.

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Option 2: Obtain funding through a holding companyExample 1

BMC Ltd

Fast50 Ltd

John • John owns shares in The Best Managed Company

Ltd and is interested in acquiring shares in Fast50 Ltd (trading company).

• BMC Ltd obtains third party funding and uses the funds to acquire 100% of the ordinary share capital in Fast50.

• John is appointed as a director of Fast50 (he is already a director of BMC).

• A deduction is available at the level of BMC in respect of interest payments made during the year.

• Any interest relief that is not used against the profits of BMC can be used by Fast50 against their profits.

• How does BMC fund its interest payments?

• Relief would also be available if in the scenario above Fast50 Ltd was a rental company.

Bank

BMC acquires Fast50

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Option 2: Obtain funding through a holding company

• A year later, BMC obtains a bank loan and uses the funds to lend to Fast50.

• Fast50 then uses the loan to fund a foreign expansion.

• John is a director of both BMC & Fast50. • A deduction is available at the level of BMC

in respect of interest payments made during the year.

• Any interest relief that is not utilised against the profits of BMC can be used by Fast50 against its profits.

• Should BMC charge interest to Fast50?

• What if Fast50 is a non-Irish company?

BMC Ltd

Fast 50 Ltd

John

Example 2

Bank

BMC lends to Fast50

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Reviewing Loan Agreements

Ensure purpose of loan is documented.

Review gross up clauses within the loan agreement.

Protect against change in law Lender warrants it is a Qualifying Lender E.g. change in law: -

o Interest due of €100k payable to lendero Borrower deducts WHT of €20k and pays to Revenueo Pays €80k of interest to lender plus €20k gross up paymento If gross up clause - Lender receives €100ko Total cost to borrower €120k i.e. additional cost of €20k.

Review assignment clauses within the loan agreement.

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Get your shop in order

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Get your shop in order1) Internal health check

Be ready for a due diligence exercise

Common issuesCompliance not up to datePayroll taxesPayments to contractors R&D tax creditsOverseas permanent

establishment/taxable presenceClose company issues

Create a positive impression

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Get your shop in order1) Internal health check

Be ready for a due diligence exercise

Common issues Compliance not up to date Payroll taxes Payments to contractors R&D tax credits Overseas permanent establishment/taxable

presence Close company issues

Create a positive impression

2) Structure review

Appropriate & efficient structure in place?

An efficient structure should support better cash-flow & better facilitate the repayment of debt.

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Be prepared

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Be prepared • Is existing structure fit for purpose for

the shareholders?

• Does it give sufficient flexibility?

• What could a future exit look like and are you prepared?

Carve out of a portion of the business into a separate company

Consider how current structure affects eligibility for Entrepreneur Relief

Should a holding company be put in place?

• Stay tuned for a separate session on planning for exit

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Questions


Thank you

Justin founded Version 1 in 1996 with John Mullen. He has led

Version 1 through organic growth and strategic acquisitions to

become one of the fastest growing IT services companies in

Western Europe. Under Justin’s strategic direction Version 1

has doubled both profitability and revenue over the last few

years, while at the same time delivering consistent

improvement in customer satisfaction and better than world-

class employee engagement.

John Doddy, Partner, Head of Debt & Capital Advisory David Shanahan, Partner, Tax

David Martin, Director, Debt & Capital Advisory Anya Cummins, Partner, Head of M&A

Keynote: Justin Keatinge, Co – Founder, Version 1

E: [email protected] T: 01417 2594

E: [email protected] T: 01 417 2522E: [email protected] T: 01 417 2240

E: [email protected] T: 01 417 2598

www.version1.comLaura McCoy, Director, M&AE: [email protected] T: 01 417 3447

mailto:[email protected]


November 2017

Funding for growth

Best Managed Companies Breakfast Session

headline verdana bold · partner, tax and legal, deloitte ... what debt funders are looking for and...

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