From Cold Call to Closed Deal: How a Private Equity Investment Comes Together, Part 3 – The Dotted Line
“She thinks $60 million is a discounted price? Can someone shoot her with an animal tranquilizer gun until she snaps out of it?” John says, looking around in disbelief at all the other Partners.
David turns to you and his eyes light up as a new idea percolates to the top of his head, and then sputters out of his mouth.
“You do know about the special analyst bonus, right?”
Everyone else in the room laughs, as you contemplate whether or not they really want you to tranquilize the CEO.
$60 million would be 6x EBITDA – a reasonable price for a larger company – but significantly higher than what you’d pay for a small, Founder-dominated business in a niche market.
David speaks up once again as the laughter subsides.
“And let’s not forget about her other demands: she wants to roll over 20% of her ownership and put aside 5% in an options pool for the management team.”
“So we’re paying for an overpriced business and then giving up 25% for no apparent reason. This sounds like a better investment than finding Google in 1998,” John replies while rolling his eyes.
Everyone else sits there in silence as you weigh your options before speaking up.
“Well,” you say, “On a positive note, I think I could call in a few chips to get the financing in place.”
“What bank would even look at this? It’s too small for any of the usual suspects,” David points out.
“Right now everyone’s desperate for business – in normal times they’d say no, but beggars can’t be choosers.”
Calling in the Chips
You crawl back to your office and wonder if you can pull off the financing for this deal – your line to all the Partners was a desperate bluff, and you don’t actually have much to offer bankers.
Plus, you’ll have to hear even more tales of $1500 bottle service bills now that you’re going back to the usual suspects to ask for help.
“This is definitely below the bar,” says your banker friend after you finish outlining the deal.
“I realize $30 million of debt is on the low side, but with the way the market is -” you respond as he cuts you off.
“Look, even if this were the apocalypse and banks were failing left and right, we still wouldn’t look at this – the fees are just too low and it’s not worth our time.”
“We’ve sent you guys a lot of business in the past few years – probably more than any other firm…”
“Yes, and they were all small deals. I appreciate the effort, but the MDs want us to pursue the big game from now on.”
You’ve left your door open for this call, so your favorite unannounced visitor happens to be walking by, overhears your conversation, and steps into your room.
David motions for you to step away and then puts the call on speakerphone.
“We’re willing to give you all future business from our firm over the next year, including refinancings and all sell-side mandates. No competition at all for you,” he promises without hesitation.
“Can you… actually guarantee that?” the banker asks with a rising tone.
You fold your arms and squint at David, wondering what he’s gotten himself into this time.
“We’re planning to flip it in a year or two, and possibly do a refinancing before that – should be at least $10 million in fees for you altogether,” he states without so much as a blink.
“OK then. I’ll run this up the chain and see what they think. Thanks for the offer,” the banker replies.
You turn off the speakerphone, spin your Aeron chair around to face David, and wait for him to explain what just happened.
“Don’t worry,” he reassures you, “They’re bankers – they’ll all be fired or will be at another firm in another year or two anyway. No harm done, and now this deal goes through if we can work out the price and rollover.”
“Sorry, but we just can’t get our heads around $60 million,” John says to Nancy, who’s sitting at the head of the table in your conference room in front of all the Partners.
“We could get to $50 million max, but even that’s pushing it. Nothing personal, but the numbers just don’t work out in that range.”
Nancy continues staring at the slide presentation in front of her and attempts to make sense of the returns analysis, but it might as well be Martian to her.
“Understood, but $60 really is the bottom of my range here. With the margins we have, I could just keep running this business for years and make more money than what you’re offering. And unless I can retain at least 20% ownership, my incentive just isn’t strong enough.”
Both sides of the table stare at each other for a few seconds before John breaks the silence.
“We’ll be in touch if anything changes.”
Nancy stands up and walks out of the room, waving goodbye to everyone before closing the door behind her.
“It’s 100% posturing,” David points out, “There’s no way she seriously expects to get $60 million for the business and keep 20% for herself. And we know she wants to leave anyway, so it’s not as if she’s seriously considering running it for another 5 years.”
“That may be true,” says John, “But the numbers really don’twork at those levels – there’s so much uncertainty around the exit that this only makes sense at $50 million max. So we either convince her or we don’t do this deal.”
It’s time to don your Captain Obvious Hat and point out what everyone else is missing.
“What if we just flip it after a year or two? It’s much easier to get to a solid return over a short time period, and that way we can even tell her that she can leave the company after a certain period – once it’s no longer owned by us,” you propose.
David sits back in his chair and puts his hand on his chin as he contemplates your idea.
“That’s true – I doubt she’ll even understand why we’d offer that. And she won’t understand the risk to her if she does leave, so it might just work if we pitch it the right way.”
He cleverly fails to mention how the bankers doing the financing are already expecting you to flip it quickly – hearing that might cause John to toss him out the window.
“OK,” John agrees, “Go back to her and propose $50 million with a 20% rollover and say that in exchange for the lower price, we won’t make her stay beyond 2 years or sign a non-compete.”
Limited Partners = Limited Support?
“And we see this as an exciting way to start investing in the technology space – without all the risk that a bigger investment would entail.”
John is presenting IonX and a few other investments they’re looking at – all of which are much further away – and hoping that the LPs remain confident enough to keep investing in future funds.
Most of them produce nothing but poker faces as John goes through all his slides.
“We’re getting this at a discounted price, and we think it could be a quick-flip for a 20% return in less than a year.”
One of the LPs at the end of the table immediately stands up, slams his binder of materials shut, and scurries toward the door.
“Is… something wrong, Paul?” John asks while folding his hands in front of him.
About to open the door and leap away from the meeting, Paul turns around, drops his binder on the table, and grabs the door knob before speaking up.
“Yeah, you. You and your firm.”
Everyone else turns around to face him as whispers fill the crowded room.
“You raised $750 million for your new fund from all of us, claiming that you had all these great opportunities – and what do you do? You sit on that cash without doing anything for a year, and then you finally bring us a piece of dog crap, put a ribbon on top, and try to call it a gift.”
John raises both hand, blinks, and motions for Paul not to leave the room quite yet.
“I understand why you might be upset, but with the way the market’s been lately…”
Paul cuts him off before he can finish, turning around and removing his hand from the doorknob. “Then why are our other private equity funds still doing real deals? I can’t veto this or tell you not to do it, but I’m not happy about it.”
John walks toward him, binder in hand. “Look, I understand why you might not like IonX, but we have plenty of other…”
Paul opens the door, storms out, and slams it shut.
Back at the Office…
You and David are reviewing the loan documentation from the bank and are looking at different financing options for the deal.
“With the margins they have we should just pick the cheapest option – I’m more concerned with broken covenants than with interest payments,” David points out.
You turn toward your monitor and look at an LBO model with the different financing options built in before swiveling around in your chair and responding.
“That’s true, but we still don’t even know if Nancy is going along with this. I’m not convinced she’s gonna take the bait.”
Just as David leans back and prepares to respond, your phone rings. Time for the speakerphone.
“Hi, it’s Nancy,” the voice announces. “I’ve considered your offer and I’m prepared to move forward as long as you don’t make me sign a non-compete.”
You and David look at each other with your eyes widened and mouths gaping open. But there must be a catch – what would it be?
“But,” she continues, “Some of my managers have figured out what’s going on, and they’re not about to accept a new owner. They know me and like me, and they’re nervous about what will change.”
David puts his hands down on your desk and responds, “We’re not going to change a thing. You will still be running everything; it’s just that you’ll have all of our firm’s resources at your disposal…”
“That may be true, but I think they’d be more confident if all of you came to meet them in-person,” Nancy retorts.
“That would be a great idea,” David says while rolling his eyes and searching for your stress relief ball. “We’re all looking forward to flying out and meeting you.”
“I’ll be in touch with some dates,” she responds, “And please make sure it’s everyone – we should plan for at least a week so they can get to know your team.”
As she hangs up, you and David sit there looking at each other and David turns his gaze toward your window.
“Think they’ll have any beaches there?”
One Door Over…
John is cycling through the call history on his phone and looks down at the 15 unreturned calls he’s made to Paul in the past week. Limited Partners might be “limited,” but that doesn’t prevent them from being passive-aggressive and ignoring contact when it suits them.
He walks over to his whiteboard and looks at the pipeline of potential investments, noting that everything else is at least 6-9 months away.
His phone rings and he slides back to his desk to answer it.
“So, John, ready for some more news on IonX?” David announces.
“Can you start with the good news first?” John replies.
“No good news this time. Do you have a free week in your schedule anytime soon? They want us to fly out and meet their team.”
John glances back at his whiteboard and then the call log on his phone. “Whatever it takes – talk to Suzanne about my schedule,” he says before hanging up.
Leaning back in his chair, he dials the main line, finally resigning himself to his “Plan C” option.
“Get me the new guy, Martin.”
A minute later, Martin shows up at John’s door and attempts to open it three times before finally gathering enough strength to push it open on his fourth try.
“You… wanted to see me, sir?” he stutters while wobbling into the room.
John laughs, stands up, and walks across the room to Martin, standing an inch away from him as he recites his speech.
“There’s no need for formalities. I’ve heard good things about your family. I’d like you to tell me more.”
He smiles and stares Martin straight in the eye, waiting for his response.
It’s the next week, and all the Partners have flown out to meet IonX in-person. Apparently “everyone” means “everyone except for the person who’s actually doing the work.”
But the office is quiet again, and no one is checking your calling logs now that you and Martin are the only ones there. You’ve been handing off all the grunt work to him – anytime a banker or lawyer has a question, he’s the one in charge.
David has been updating you the whole time, and it looks like the management team is growing more confident that nothing will change post-transaction.
And you’ve been forwarding the in-progress definitive agreement that the legal team has been drafting.
“You should have seen these guys when they saw us,” David says at the tail-end of one of his update calls.
“It’s like they had never seen people dressed in suits before. They were waiting for us to morph into Gekko or Bateman and start murdering people.”
“Sounds like a fun trip,” you say, putting the call on speakerphone and standing up before moving over to your window. “Is it going to close?”
“90% certain now,” David reassures you, “And since bonus season is only a few weeks away, you can bet that we’ll remember everything you’ve done here.”
Your eyes light up as you peer out the window and see a BMW parking right next to your usual spot.
“That’s great,” you say, “So are there any beaches there?”
Pension Power Play
Paul strolls into the entrance of the Ritz Carlton, going on about another investment on his phone and simultaneously typing like a fiend on his Blackberry.
He’s met by a tall, lanky man walking in with a grey suit and a binder of printouts in his hands. He walks over to Paul but gets rebuffed as Paul points to his phone and rolls his eyes.
Finally the call ends, Paul turns toward him and shakes his hand, and they walk toward the interior of the restaurant.
“I was surprised when you called,” Paul says in a cheery voice. “I didn’t think I would see you again after what happened on the Fincher account.”
“Let’s let bygones be bygones,” says the other man. “We’d both do much better as allies rather than enemies.”
They sit down and order medium-rare steak along with a $1000 bottle of 1982 Haut-Brion.
“So why did you really call me, Simon?” Paul asks as he sips his wine and arranges his napkin on his lap.
“I wanted to tell you about a few new investments we’re looking at. In this market no one’s doing any deals except for the distressed funds, which are a huge part of our portfolio.”
“So you’ve just mysteriously decided to extend the olive branch and give me access to all these funds that are actually beating the market?”
Simon turns to the bottle and pours himself a glass, holding it up and reading off the label.
“This is the 1982. Have you tried the ’72 before? I hear it’s even better.”
Paul rolls his eyes, puts down his glass, and then reaches over and takes the wine bottle out of Simon’s hands and places it down on the table.
“Cut the crap. I know you’re not just giving me this gift out of the kindness of your heart, so what do you want in exchange?”
“I want you to look the other way on John and his firm’s performance over the past year. And when they raise another fund, I want you to invest – and I want you to let me into the deal as well.”
Paul starts laughing so hard that he snorts, with red wine nearly bursting out of his nostrils.
“So John put you up to this. Ignore his horrible investments, and you’ll give me a piece of these distressed funds.”
“I didn’t even hear about this from John,” Simon says, “But word of your… displeasure… has spread. They’ve had great performance in the past, and I want to get in on their next fund. The only way that’s gonna happen is if you continue to support them, and then bring me in as well.”
Paul stops laughing for a second, glances up at the chandeliers on the ceiling, and then over at Simon once again.
“Even if I were stupid enough to do this, what could you give me in return? No fund is up more than 10% this year…”
Simon opens up his binder, takes out a few documents, and tosses them across the table to Paul before he cuts him off with his response.
“Those 3 are up 50% year-to-date. They’re closed to new investors, but I can get you in – if you look the other way and keep investing in John’s fund.”
Paul stares at the fund performance documents before tossing them aside and looking up at Simon once again and smirking.
“This just seems too good to be true. And I don’t know why you’re offering me this deal. You’re sure your son isn’t working for John or something?”
The Dotted Line… and Your Bonus?
You stand outside John’s door, waiting for him to summon you in. It’s bonus season, and everyone in the office is acting like 10-year old kids on Christmas morning.
He opens the door and greets you in a cheery voice.
“Congrats!” he shouts, “We did it. The funds were just wired the other day, the loans are in place, and Nancy hasn’t even run off to a tropical island and abandoned everyone. Yet.”
He waves around the signed definitive agreement while leaning back in his chair and pointing to the dotted line on the page.
“So, about your bonus. We realize how much you contributed to the IonX deal, and we really want to reward you for your performance.”
This better be good – anything less than a 20% raise over last year might cause you to jump out your window after what you’ve been through getting this deal done.
He hands you a slip of paper, and you stare at it in disbelief as your mouth drops open and stays there until you look up to face him once again.
“This is down 10% over last year – I brought in the IonX deal and got it done. Without me, you’d have 0 closed deals this year.”
“We know that. But look at what happened to the market – it’s a train wreck everywhere. Everyone else’s bonus was down 30%. And let’s be fair, David also helped get this deal done. You know we can’t just give juniors arbitrary pay.”
An image of David sitting around on the beach while “getting to know” Nancy and her team pops into your head.
“And if it weren’t for Martin, we wouldn’t have had LP support. He did terrific work for a new guy!”
Up until now, you hadn’t even known that Martin contributed anything aside from confusion and answers to random due diligence questions.
“His family’s very well-connected. But I’m sure you understand that, right? You really have to be a team player to succeed as an investor.”
You thank John, turn around, and leave the room, trying your hardest not to slam the door behind you.
You walk back to your office, slump down in your chair, and pick up the phone to call your friend at a larger fund and learn what bonuses at normal places were like this year.
But as you place the call, you decide that there’s something else you’re more curious about first.
“Hey there,” you say, “Just wanted to find out about bonuses this year. But before we get to that, I just wanted to know – are you guys hiring?”
The Full Series
In case you missed parts 1 and 2, you can get them right here:
- From Cold Call to Closed Deal: How a Private Equity Investment Comes Together, Part 1 – The Idea
- From Cold Call to Closed Deal: How a Private Equity Investment Comes Together, Part 2 – The Deal?
Coming Up Next: The Web Series
I’m excited to announce that we are turning this 3-part short story into a 6-episode web series that loosely follows the storyline here, but is significantly different – “different” as in better.
I (Brian) am writing the series and financing it, and my good friend Goldie will be producing.
There were a few suggestions to write a novel, but I am much more interested in turning this into a series. And if you follow me on Twitter, you also know that I am borderline obsessed with serialized TV shows and films.
We are aiming to film and edit this by the end of 2011, and then release it in early 2012.
There will be a trailer, and if you’re good you might even get to read the script for the first episode.
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