DealLawyers.com Blog

A recent Womble Bond Dickinson memo says that private equity funds and strategic investors are increasingly interested in taking minority positions in target companies. This excerpt discusses private equity funds’ rationale for this move and its implications:

Financial investors, particularly private equity firms, regularly rely on debt to extend their reach and enhance their return on capital. However, with high interest rates showing little sign of receding soon, the cost of this debt has made debt-financed acquisitions less attractive. In addition, the uncertain market outlook has caused these firms to seek greater protection from downside risk. As a result, private equity firms are more frequently partnering with co-investors and asking sellers to retain more equity in the target company.

Firms that have traditionally targeted buy-out options are engaging in more majority recapitalization transactions instead of relying on earnouts to bridge any valuation gap, and majority recapitalization firms are expanding their focus on minority investments. The move into minority investments allows private equity firms to further diversify their investments and mitigate potentially larger downside scenarios with majority recapitalizations. This shift has brought new players into and focus on the venture capital market.

On the strategic side, the memo says that minority investments are frequently a key third prong of large operating companies’ innovation strategies, along with traditional M&A and internal R&D. Strategics often use minority investments to, among other things, obtain early access to breakthrough technologies and obtain preferential commercial rights.  The memo also highlights some of the key protections that minority investors should seek during the negotiation process.

– John Jenkins