Club Deal

A buyout means taking control. Control usually means 51% or more of a company's share capital or voting rights.

That is a very large cheque. Buying half of a company costs far more than buying a growth stake in it.

So sometimes one fund cannot do it alone. Several private equity investors then act in concert and buy the controlling stake together. The workbook calls that a club deal.

The reason is not shyness. The workbook lists three real obstacles to a fund doing buyouts: they need larger corpuses, they concentrate risk, and they raise funding challenges. A club spreads all three.

There is also a rule pushing in the same direction. An AIF scheme may not put more than a set share of its money into any one company. So a big enough target can break that limit for a single fund and not for four funds together.

One caution. A club deal is a club of funds, not a crowd of small investors. That is a different thing.

Section 8.3 gives the definition inside the definition of a buyout: a buyout is a specialised transaction in private equity investing space wherein a controlling stake (usually 51% or more) is bought by one or more private equity investors acting in concert (known as Club Deals).

What a club deal is not. Section 8.3 also separates a buyout from ordinary private equity by the type of share bought. Private equity subscribes to primary shares and provides financing, does not seek control, and aims at investment gains. A buyout acquires secondary shares from the controlling shareholders, and the whole object is control. A club deal is therefore several funds buying secondary shares together.

Why funds club. The workbook names the hindrances to a private equity fund transforming into a buyout fund:

• buyouts require larger corpuses;
• they involve risk concentration;
• they raise funding challenges;
• and they need sufficient depth and maturity in the acquisitions market, so that suitable targets are available for sale by their controlling shareholders.

The concentration limits are the arithmetic behind the funding challenge. Chapter 6, Table 6.1, caps a single investee company:

A Category II scheme therefore cannot spend more than a quarter of its investable funds on one target, however attractive. That single line explains why a control price above a quarter of a fund's money has to be shared.

Where a club deal leads. Because the price is large and the target's cash flows are usually strong, a clubbed buyout is often a leveraged buyout. A classic LBO is financed 70% debt and 30% equity, with the debt and equity pooled in a special purpose acquisition vehicle that gives the lenders a ring-fenced secured structure. In a club deal, the equity slice of that structure is subscribed by several funds rather than one.

Indian market context. The workbook records that the Indian M&A market has grown by leaps and bounds over the past two decades and has witnessed several buyout transactions by large global funds such as Blackstone, TPG and KKR.

Vindhya Engineering Ltd is a profitable unlisted auto-components maker. Its promoter family wants out. The control price for 51% is Rs 1,800 crore.

Sahyadri Buyout Fund II, a Category II AIF, has investable funds of Rs 2,400 crore and wants the deal.

Can it do it alone? The Category II cap is 25% of investable funds in one investee company.

So no. Even ignoring the sense of putting three-quarters of the fund into one name, the regulation stops it at Rs 600 crore.

The club. Three funds come together and act in concert:

No single fund holds control. Together they do, because they are acting in concert. Each fund is also inside its own 25% concentration limit — Sahyadri at exactly Rs 600 crore of Rs 2,400 crore.

Add leverage and the cheque shrinks again. Structure it as an LBO through an acquisition company on the classic 70:30 split of the Rs 1,800 crore:

Now Rs 540 crore of equity buys control of a Rs 1,800 crore stake. Sahyadri's slice falls to about Rs 180 crore — comfortably inside its cap, and small enough that it could arguably have gone alone. Which is exactly why the two techniques, clubbing and leverage, appear together in the same section of the workbook.

And the risk the club does not remove. The workbook warns that LBO structures carry a huge embedded risk of default and bankruptcy if the target's future performance does not pan out. Three funds sharing that risk each lose less; none of them loses nothing.

Chapter 8 (Alternative Investment Fund Structuring), section 8.3 on buyout transactions, introduces club deals in the opening definition, alongside taking private and, a page later, secondary buyout. Section 8.3.1 then gives the MBO, LBO and MBI types. Chapter 11, section 11.1.2, restates the buyout and LBO strategy.

Expect a one-line definition question: a buyout in which the controlling stake is bought by one or more private equity investors acting in concert is known as a club deal. Expect the 51% control threshold in the same breath. The harder question asks why funds club, and the answer is the workbook's own list of hindrances — larger corpuses, risk concentration and funding challenges.

• A club deal is several private equity funds, not a group of small investors. A syndicate is accredited investors pooling behind a lead investor into a start-up. Different investors, different stage, different regulation.
• Acting in concert is what creates control. No single member of the club needs 51%.
• A club deal is not automatically leveraged. Leverage makes it an LBO; clubbing and leverage are two separate techniques that often appear together.
• The concentration cap is 25% of investable funds for Categories I and II, and 10% for Category III. The Category III figure is the one candidates transplant.
• Buyouts buy secondary shares for control; growth private equity buys primary shares for financing. A club deal is on the buyout side of that line.
• Taking private is about the target being listed, not about how many funds are buying. A club deal can take a company private, but the two terms answer different questions.