Supporting private equity funds: pre-acquisition work
Welcome to the latest instalment of our blog series exploring the crucial role of business credit rating insight, improvement, and monitoring for private equity funds, particularly in the pre-acquisition phase. In my last blog we covered how credit reference agency scores and credit limit recommendations can vary based on agency, and the impact this can have on any business.
What exactly does “pre-acquisition” mean?
Simply put, it’s the stage before potential buyers make a purchase or bid for a company. But why are the business credit ratings of a target business so important to a prospective buyer? The answer is quite simple.
Understanding how the broader business credit market perceives the target business provides valuable insights. It sheds light on the trade terms offered by suppliers, the target company’s capacity to secure contracts successfully, and its potential to access essential funding without external support, such as a parent company guarantee. These factors hold significant weight, each varying in importance based on the industry and nature of the target business’s operations.
Our comprehensive free company Credit Insight report integrates data from leading agencies such as Experian, Creditsafe, Equifax, and Dun & Bradstreet.
Here’s what you can expect to find:
- Current business credit ratings: gain an overview of the target company’s current business credit ratings across all the agencies.
- 12-month rating range: understand the fluctuations in business credit ratings over the past year, including the maximum and minimum ratings recorded.
- Recommended credit limits: explore the current recommended credit limits provided by each agency, offering valuable guidance for financial decisions.
- 12-month limit range: delve into the historical maximum and minimum recommended credit limits over the past year.
- Search volume insights: access data on search volumes conducted on the company, providing insights into its visibility and market interest.
- Days beyond terms (DBT): evaluate the company’s payment behaviour as reported by its suppliers, gauging its adherence to agreed-upon trade terms.
- Key credit insights: stay informed with crucial details such as filing dates and other pertinent credit-related information essential for comprehensive analysis.
The report delivers a holistic view of the target company’s credit standing. In doing so, it empowers you with the knowledge needed to make informed investment decisions in the dynamic landscape of private equity.
How is this valuable?
Consider a scenario where a private equity fund is eyeing a limited company for investment or acquisition. Before proceeding with the deal, the fund manager requests a free report from Lightbulb. The findings reveal robust business credit ratings and credit limits for a company operating in a capital-intensive sector. However, it’s crucial to note that any disruption to these ratings could significantly impact supplier support sentiment, ultimately affecting cash flow and working capital.
One common strategy employed by private equity funds is to restructure the company by establishing a TopCo and MidCo holding company above the operational entity (OpCo). Additionally, the fund may appoint portfolio private equity directors, leading to potential changes in the board composition. While these changes aim to enhance operational efficiency and maximise returns, they can also trigger immediate negative movements in business credit ratings and credit limits, especially post-filing with Companies House.
Understanding the repercussions of these changes is paramount. By proactively addressing supplier concerns and minimising disruptions, private equity funds can ensure that their invested capital is utilised as intended, rather than being diverted to mitigate adverse effects on cash flow and working capital.
Here’s a worked example to show the impact that an acquisition can have on trade terms:
The graphs show pre-acquisition and post acquisition business credit ratings and recommended credit limits for each agency. Post-acquisition reductions caused by some of the factors discussed above.
Therefore, the working capital and cash have been negatively impacted by c.£4m.
Here’s how we arrived at that figure:
Six key suppliers use Agency A to approve credit limits for the limited company. A £200k recommended credit limit drop across six key suppliers is £1.2m in reduced supplier terms and therefore cash held in the business.
Eight key suppliers use Agency B to approve credit limits for the limited company. A £175k recommended credit limit drop across eight key suppliers is £1.4m in reduced supplier terms and therefore cash held in the business.
Three key suppliers use Agency C to approve credit limits for the limited company. A £40k recommended credit limit drop across three key suppliers is £120k in reduced supplier terms and therefore cash held in the business.
10 key suppliers use Agency D to approve credit limits for the limited company. A £305k recommended credit limit drop across 10 key suppliers is £3.05m in reduced supplier terms and therefore cash held in the business.
It’s not hard to reach £4m from the figures above.
If this was not in the original investment appraisal, then this can be a headache for both the investor and the acquired entity.
What can be done about it?
The first step is to understand your current limits and ratings. Get this from all agencies in our free credit report.
