December 8, 2017
Interviewed by: Privcap
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Rule-Breakers Will Win in Private Equity

Experts from The Lucas Group explain how traditional deal terms are being abandoned by private equity firms that want to stand out from the competition.

Experts from The Lucas Group explain how traditional deal terms are being abandoned by private equity firms that want to stand out from the competition.

Rule-Breakers Will Win in Private Equity

Jay Lucas, The Lucas Group:

Private equity, like so many other industries, as it goes on over time, becomes calcified. Everyone in private equity today seems to be playing by basically the same rules. In other words, you go raise a fund, you deploy that fund against eight or 10 deals, you have a certain time period for holding, and you have a mandate against which kind of industries you’re going to be investing in, as well as eight or 10 other players who are competing for those same deals. One of the things that you’re constrained in is that you need to take a control position, so the numbers all start to focus on about the same number that everybody can pay for the same deals. There’s no way to get any advantage and it essentially becomes a commodity. And, of course, prices typically go up—it’s much more difficult to earn attractive returns.

We’ve seen a number of ways that people are trying to break those rules. One is that we’re seeing more and more people going out for mandates that don’t require control investments. They’re looking for minority positions. They’re looking for minority positions that allow them to maybe claw back control if things aren’t going the right way. And we’re seeing funds change so that they can actually have much, much longer hold periods, which I think makes a ton of sense.

Ian Knowles, The Lucas Group:

For the last 20 or 25 years, the traditional private equity structure has been extremely confined to a very specific way of getting deals done. For entrepreneurs, for business leaders, there’s an abundance of capital out there looking for great deals and great business leaders to support.

If you’re looking to be somebody to continue to win deals, it will be vital to break down those barriers of what traditional private equity has been. Get more creative in your deal structure.

Whether it’s the preferred return, whether it’s the liquidation preference and however it’s structured, whether it’s the claw back, the drag-along, the tag-along—all of these very traditional private equity requirements when they send the term sheet out, there’s ways to structure deals that are favorable to everybody. That allows everybody to be more on the same side of the table.

One of those models is the equity line model where, over time, based on performance, management teams have the ability to earn back equity based on cash-flow performance. That way they’re participating in the equity. The private equity firm is getting the cash flow. They’re participating in the cash flow. Everybody is working towards the same goal of building a business that’s of long-term value.

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