When Jon Moulton addressed a private equity conference in Germany in February, the audience was left in little doubt as to his feelings about the industry’s immediate future.

The managing partner of investor Alchemy Partners predicted that this year would see some large private equity failures due to economic uncertainty, and that the industry would receive weak returns from its exits.

He blamed private equity firms for not maintaining high enough standards of due diligence and risk assessment during the recent boom years. “Buy-outs were done on mythical numbers like pro-forma, adjusted, normalised EBITDA, which almost always turned out to be 20 per cent higher than reality.

“We were buying false numbers and doing it willingly, but the quality of what we were doing had come down,” he added. “It is the same thing that was going on in the US sub-prime market.”

M&A’s Mark Dunne examines the current state of the market and if those backing the buy-outs agree with him.

There are two sides to every buy-out

Despite Jon Moulton’s pessimistic view of the private equity market, M&A’s Mark Dunne talks to two players about how they worked together to get a deal away

Management team

Last year Mark Gordon was ready for a new challenge. The chartered accountant had spent his career working for engineering-based companies, but decided it was time to run his own business.

While looking for an opportunity, he was approached by one of his contacts, James Stander of M&A practice Ronin, to act as a consultant to mechanical and electrical engineering services provider T Jolly.

Gordon worked with its owners, Alan and Susan Stoker, dealing with management issues. When the husband and wife team decided to retire after running the business for almost 30 years, they felt Gordon teaming up with the management team was the best option going forward.

“T Jolly has a good pedigree,” he said. “It’s an established business in the locality with long-standing client relationships, a strong management team and a good infrastructure.”

Gordon became chief executive after completing the deal along with T Jolly’s existing managing director George Jackson. They were joined by head of finance Sue Lea with Joe Turner and John Slater, its heads of installation and maintenance respectively.

A friend in need

He turned to his old friend Joseph Bergin, a director at NBGI Private Equity, to fund the deal. “I have known Joseph for some time and went through my thoughts on the business with him.”

Bergin decided to back Gordon and within five months the deal was completed, with the private equity firm taking a majority shareholding in return for its seven-figure investment. Also taking equity in the business were Gordon and the four members of its management, who invested their own cash.

NBGI’s funding was part of a package that included debt provided by Svenska Handelsbanken. The Swedish bank was introduced to Gordon when his adviser, BDO Stoy Hayward, compiled a short list of potential providers.

We can work it out

Gordon admitted that the positive attitude of the vendors, in addition to the quality of the funders and advisers involved helped to propel the deal forward: “The main thing was that all parties worked together pretty well.

“We had a set of objectives to achieve, so when we came across a problem we sat down together and discussed it,” he added. “No one was trying to get one over the other party. We all knew that the key issue was that the owners wanted to retire and they felt if I were to team up with the management team, this would be the best outcome to secure the future of the business.”

Despite the close working relationship of the teams involved, Gordon admitted that knowing Bergin didn’t make it any easier to secure the funding needed. “I don’t do this regularly, but the market for raising funds seems to be relatively restrictive. You get a sense of caution coming through from funding institutions, but for the right deal and the right structure the funding is there.”

Bergin and Gordon’s working partnership hasn’t come to an end following the completion of the deal. The new owners are planning to develop the business through acquisitions, which will be funded by further investment from NBGI.

These potential deals will be identified by Stander, who will be reviewing the market for opportunities. “If the right acquisitions come along we would be in a stronger position to react to them,” Gordon said.

Private equity

When Mark Gordon approached Joseph Bergin with his idea to join T Jolly’s management in buying the mechanical and electrical engineering specialist, the private equity funder saw more than one highlight in his plan.

For Bergin, a director of NBGI Private Equity, the company was operating in an interesting market and the buy-out was being led by Gordon, who he describes as an experienced, “driven and talented guy”.

With rising costs and the need for new buildings to be energy efficient, Bergin sees the company benefiting from this rising demand. “If you can design buildings and their mechanical/electrical systems in a more intelligent way, you can make large cost savings,” Bergin said. “T Jolly is a business that can do that.”

He added that the most attractive point in T Jolly’s market is that it is heading for change, making it a perfect deal for the firm. “Generally, private equity makes money in situations where someone has a particular expertise in a market where the fundamentals are shifting.”

Gordon confirmed that the current economic climate was not the easiest environment to have completed the deal: “There is uncertainty and some nervousness in the economy at the moment. The stock market is plunging, so that is not particularly the ideal background.”

Taxing times

But he admits that he is nervous about activity slowing down after the tax deadline. “The tax change is driving a lot of activity. Beyond that it could be a quiet summer. There are a lot of deals that are going to be completed by the end of the tax year and after that we may face a bit of a lull. I say that, but maybe next month there could be an influx of new opportunities.”

He agrees with claims made by private equity investor Jon Moulton that there will be weak returns from their exits for a while. Last year was a good year to sell businesses, and NBGI received some pretty good prices from doing that. But he concedes that the next few years are going to be a good time to buy businesses.

“Moulton is right that returns in the short-term are going to be impacted, but in the long-term we might look back at these years as being a good time to make investments,” he added.

He also backs up Moulton’s claims that 2008 could witness some private equity failures. He agrees that it seems some people paid too much for some deals at the top end of the market.

Bergin said his attitude has always been less about the price of a deal and more about the improvements he can make with the management team of the business. “These things are driven less by what is happening in the overall economy. Clearly the best time to exit is when the economy is booming and credit is plentiful.”

It seems that due to the downturn, NBGI will be holding on to T Jolly for some time. The firm’s strategy going forward will be to focus on buying businesses in the next few months. “We completed a £100 million funding last June, so we are sitting on a pile of cash that we want to invest,” Bergin said.

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