As we kick off 2023, we are optimistic that the healthcare private equity (PE) market will be resilient despite various headwinds. As you think ahead, please consider the issues and trends summarized below that may be helpful to your deal-making process. 1. Has Your Exit Window Closed? Considerations for Minority Investment and Alternative Cash Generation Models in 2023 BY BRYAN BYLICA As M&A activity slows and the credit markets become more constrained, business owners and PE sponsors with portfolio companies looking for liquidity are often faced with the prospects of lower valuations, onerous seller financing terms, or even a complete inability to sell. In these circumstances, a minority investment may provide a solution. Minority investments are useful when the company’s owner or sponsor seeks partial liquidity, growth capital, and industry expertise without giving up control of the business. PE firms have a mandate to invest their capital, even where M&A markets are slow, or a lack of access to credit markets makes traditional leveraged buyouts unworkable. In recent years, where this has been the case, PE firms have increasingly turned to minority investments as an attractive outlet for this capital. However, business owners and sponsors should consider several important factors when contemplating whether to pursue and ultimately accept a minority investment from a PE firm. Minority equity investments often take the form of convertible preferred stock and will come with material governance and financial rights. PE firms will typically seek one (or more) board seats and board observer rights, as well as consent rights over certain fundamental and operational activities of the business. The preferred stock will likely contain minimum return thresholds that act as a liquidity preference (over and above the mere return of capital) or put rights that allow the PE firm to sell the preferred stock back to the company for a predetermined price based on a formula or initiate a sale process to achieve the PE firm’s desired liquidity. The minimum return thresholds may be based on an accruing dividend akin to a preferred return hurdle and may be coupled with a multiple on invested capital hurdle. The put right may act as a de facto sale right if the company is not able to refinance the PE firm’s minority investment. Understanding how these rights work is key to striking a balance that results in a partnership between the company and the PE firm that ultimately results in a positive outcome for both parties. As you evaluate whether a minority investment from a PE firm may be suitable for your portfolio company, you should carefully consider the implications of partnering with a PE firm for the next several years and how it may alter, positively and negatively, how the company has historically operated. Because PE firms do not compete for minority investments on price alone, companies seeking minority investments should pay attention to the ancillary benefits, beyond valuation, that a PE firm offers. These often include access and credibility in financial markets, industry experience and expertise, more specific expertise that overlaps with the company’s growth priorities, and access to operating partners that fill specific needs. Financial considerations beyond valuation include whether the PE firm can provide sufficient capital to meet the business’ up-front needs and whether it can scale with the business as it grows. 2. Considerations in the Debt Markets for 2023 – Current and Future Credit Facilities BY KATIE DAY With the Fed suggesting the target rate may go higher than initially expected and inflation and supply chain issues continuing to create commodity pricing pressures, we expect uncertainty to persist in debt financing trends for early 2023. Companies without pressing debt restructuring needs may prefer a wait-and-see approach on financing and refinancing transactions, while companies particularly burdened by increasing commodity prices and rising rates may want to explore relationships with non-traditional financing sources, given traditional lenders may seek to push certain borrowers of their portfolios to correct for heightened risk and to redeploy funds at a higher rate. Non-traditional lenders will seek to take advantage of opportunities created by traditional lenders pushing borrowers elsewhere.
2 | BASS, BERRY & SIMS
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