If you want to take your restaurant, hotel or pub & bar business to the next level but have exhausted your own resources, run out of deep-pocketed friends and family and the response of the banks is still akin to ‘computer says no’, then PE can seem an attractive option.
Giving away an equity stake in your company and a seat on the Board in return for financial backing is, as our two case-studies show, often the right move if you are looking to expand or want to provide an exit for initial start-up investors.
For some operators a deal with a PE house might sound out of reach or far-removed from how they run their business but that can be a mistake on two levels:
- Firstly, private equity deals take many forms including, in the case of Barburrito, relatively low-level investment of around £3m in return for a minority stake.
- Secondly, a PE deal should be treated as any other - the personal relationship comes first and negotiations should revolve around the nature of the business not just numbers and the bottom line. It was a formula that resulted in success for our second case-study: Amber Taverns.
“People are crucial for any private equity investor,” said Andy Gregory, regional director of the Business Growth Fund (BGF).
“Once we are in we are fully committed and want to be aligned with the entrepreneur or entrepreneurs – management is critical. Businesses tend to be through that start-up phase with a handful of sites so it is clear that the concept is proven and there is enough evidence that it has happened a good few times to give us confidence to back a roll-out.”
It should also be noted that for people looking for start-up cash, private equity deals with angel investors or Venture Capital Trusts (VCTs) can be an option to kick-start your business – the investments are lower than those we feature below but the risks for both parties are higher.
Owners: Co-founders Morgan Davies and Paul Kilpatrick
Private equity firm: Business Growth Fund (BGF)
Funding secured: BGF invested £3.25m in Barburrito in April 2012
The burrito wars might be centred on the booming development of the concept in the nation’s capital but long before London fell in love with the Mexican snack Manchester-based Barburrito was finding a market for the food in the north.
The business began as a single site before growing to six units in Manchester, Liverpool and Leeds – however private equity funding was crucial in order to take the next step as co-founder Morgan Davies told BigHospitality.
“We had a good look at bank debt as an option,” he revealed. “I have seen a lot of examples of companies in our industry which choose the wrong mechanism and the wrong partner too early.
“We are committed to roll-out so the precursor to that is that any money we make gets re-invested back into the business. That will automatically cause a problem for a lot of banks because they are looking at cash ratios and debt/EBITDA ratios and when you are in roll-out mode of a new concept it is very hard to hit those hurdles.”
Davies’ point will ring true with hospitality operators the world over – convincing the banks to take a punt on an expanding, capital intensive business – one which requires investment of between £1m and £10m - is tricky.
“For a lot of businesses in that early stage it is almost a dead conversation – the sales executives at the banks will be very positive but when it goes through to the credit committee the decision will come back with: ‘we don’t think this can hit our hurdles’.”
However, many of those same operators in agreement with the entrepreneur when it comes to dealing with banks will still be put off giving away a stake in their business to a private equity firm which will ultimately be eyeing an exit strategy.
Davies said he had the same fears but had them allayed by a firm that was clearly going to be in it for the long-haul.
“We discovered that a lot of the private equity partners in our industry don’t start playing until you require £5m+ investment,” he said. “We didn’t need that at that stage and we didn’t want to over-dilute ourselves."
“The next thing we focused on was finding a partner that had similar aspirations to us. A lot of the traditional private equity companies are looking at a three-year time horizon with a fairly aggressive view on exit. If you are not positioned for exit after three years then you hit interest ratchets and all sorts of other problems.”
For an industry that is, as we so often hear, based on the quality of its people it can seem daunting to do a deal with a PE firm that will only be looking at the numbers. Davies’ answer: don’t sign with any investor who is personally cold with you or who only values the figures.
“We met a few investment partners that, to be honest, it didn’t matter what terms they offered us, I wouldn’t have done a deal with them because there has to be a good fit with the people,” he added.
“BGF was a good fit because they took a slightly longer-term view, they do fund that gap in the market and they are interested in companies that can grow both in terms of revenue and employment. As part of our expansion we are aiming to create 250 jobs so we fit nicely into their ethics.”
The entrepreneur explained he and his business partner had also chosen to go into business with BGF based on its ability to add more value to the company beyond simply placing a relevant non-executive director on the Board – HR, marketing, accounting and IT for example.
“We wanted the ability to tap into other businesses in our sector. The good thing with BGF is that they do have some level of focus on the leisure sector,” he said.
A private equity deal is very rarely the end of a process to find funding – it is just one part of the financing mix. Barburrito for example is now looking again at its options.
“Our aggressive expansion plans are on track – by the end of this year I am confident we will have 11 stores - so we now need to find additional capital. We are now revisiting the bank process as well as talking to BGF about follow-on funding.”
Business: Amber Taverns
Owners: LGV Capital
Private equity firm: LGV Capital
Funding secured: LGV backed a management buy-out of Amber Taverns in 2010 by acquiring the business from Unicorn Asset Management, Acuity Capital Management and MaxCap Partners – the deal is thought to have been worth in excess of £100m
The management team of Clive Preston, James Baer, Bryan Wardman, Michael Norris and Gary Roberts took a financial stake in the vehicle which acquired the pubco
Used for: The buy-out and subsequent loan from LGV Capital has helped the management team expand the business – it is currently in the process of opening one new pub every month
While both are northern-based hospitality businesses which have used private equity financing to reach the next level, Amber Taverns’ story is very different to that of Barburrito.
The pubco was founded in 2005 by a set of Venture Capital Trusts (VCTs) which by 2010 were looking for an exit from the business, as nearly all investors will be keen to do at some stage.
Although the deal that eventually came about was a full buy-out by a private equity firm it started life as many business investments still do – with a meeting of friends.
“Clive Preston, our chairman, had known Bill Priestley (MD of LGV Capital) and just spoke to him regarding advice,” James Baer, Amber Taverns managing director, told BigHospitality.
“He didn’t say we were for sale, he just asked what kind of exit there may be and Bill said LGV would be interested in looking at the business with a view to effectively backing a management buy-out and the next stage of growth.
“PE was the logical route because they were backing a business plan to grow – it wasn’t just about writing a cheque.”
In finance it is often said that you have never truly put together a comprehensive business plan until you have sought out equity investment. But, as Baer explained, the claim is very nearly a truism – Preston and Priestley may have had a personal relationship but the deal that was made was pure business.
“Once that conversation had taken place the real hard work started in terms of producing a business plan that was both backward looking at historical performance and also set out a very detailed three-year cash flow forecast on a pub-by-pub basis.”
If a partnership with a bank is the business equivalent of a long-distance relationship with regular catch-ups but breathing space between the two sides then a private equity deal is a live-in marriage and as such it is crucial to make sure everything is in the open before the deal is made.
“It is much better to get any issues out on the table before the deal is signed so there are no surprises either way of hidden agendas – doubtless there will be challenges but they are much better dealt with if the Board is united.”
The financing of their respective companies might be very different but Baer echoed Davies when he gave his tips for fellow hospitality operators looking to do a PE deal:
“Anyone considering working with private equity to grow their business does need to invest time in producing a robust business plan that will stand up to security but also getting to know the people involved in the PE firm and ensuring they understand the business and understand personal aspirations of management so everyone goes into the process fully aware of what they are signing up to.
“Bill Priestley had a track record in the industry,” Baer continued. “Particularly with the business being wet-led and in the north of England it needed someone with that understanding who could look beyond the headlines of gastro-pubs and London and see that there was value to be created with the Amber model.”
Sum total - Top tips:
- Can you mix business and pleasure? Before you sign any deal with a PE house make sure you are going into business with an individual or people you get on with and are likely to get on with when the going gets tough. Unlike generous and trusting friends, bankers based miles away and the crowd, private equity investors will be working very closely with you so a good personal relationship is crucial.
- Do your homework: Once you have a good personal relationship make sure you discuss the key points – the investor’s criteria: how much are they looking to invest and for how long; what value can they add; what will they be looking for in return – loan notes, minority/majority equity or a mix of the two and what will the situation be if things go wrong.
- Invest time to secure an investment: Past success is no guarantee of future performance and when it comes to PE funding it certainly won’t seal the deal. Your business plan needs to be robust, thorough and above all honest – you will need to invest a lot of time in writing a very detailed plan if you want to secure equity investment.
- Discuss withdrawal as well as deposit: Make sure both parties understand how long the relationship is due to last, what the goals are for both investor and business and when a PE house might be looking to make a return and head for the exit – usually private equity investors will be looking for businesses with a GPM of 70 per cent that can deliver a three times ROI.
Tomorrow, the focus turns to less traditional forms of investment – what options are there for you and your business if you don’t want to drain your friends and family but aren’t wild about turning to the banks or private equity firms either?
You can read all the articles in the Finding finance in hospitality Special Feature here.