Four tests before capital moves: a realised exit, worked through

In December 2023 the Private Equity division completed the sale of a majority position in a veterinary biologics producer held since 2020. The position had been entered at US$14 million and was sold for US$41 million after a competitive process with four qualified bidders. The proceeds did not stay in animal health. They were reallocated under the four tests that govern every movement of capital at IGUAKO Capital. This note records how each test was applied, because the tests are easier to state than to run, and the running is where the value sits.

The first test asks whether the advantage is structural or temporary. The producer held two manufacturing licences that took 31 months to obtain and a distribution network across 640 veterinary practices. Both were structural. Yet the advantage that had driven the return was licence scarcity, and a second licensed competitor was 14 months from approval. The Investment Committee concluded that the structural advantage had been priced by the buyer and that the remaining advantage was temporary. That conclusion opened the question of sale.

The second test asks whether the advantage can be converted and on what timetable. Conversion here meant a change of control that the local veterinary medicines regulator had to approve. Licence transfers in that jurisdiction had taken between five and nine months in the three prior cases the firm had observed. The sale was structured with a nine-month long-stop date and an escrow of 12 per cent of the price. Completion took seven months. The timetable was known before the process began, and the price reflected it.

The third test asks whether the proceeds have a better use. The Investment Committee compared three candidates: a follow-on in animal health, a structured credit facility in specialty materials, and a data-analytics position held through the Canadian entity. The comparison used a common measure: expected return over five years, net of the loss the firm was prepared to accept, discounted for conversion risk. The structured credit facility scored highest on that measure at 14.2 per cent against 11.8 and 10.6 per cent. US$26 million of the proceeds went to it.

The fourth test asks what loss the firm is prepared to accept. For the structured credit facility the answer was set at 35 per cent of principal, matched by a first-loss tranche held by the borrower's shareholders. For the follow-on in animal health the answer was 100 per cent of the additional commitment, which is why the follow-on was sized at US$6 million rather than the US$15 million requested. The remaining US$9 million was held as undrawn commitment capacity at the group holding company in George Town.

The exercise took eleven weeks from the Investment Committee's first paper to the final allocation. That is the cost of the method. The benefit is a portfolio that does not accumulate where returns are declining. At 31 December 2023 the client portfolio under stewardship stood at US$468 million and the proprietary balance sheet at US$402 million, across 31 portfolio companies and positions. Each of those positions passed the same four tests on entry. Each will pass them again on exit, or it will not leave.

Published 2024-01-16 by the Private Equity division. Research is prepared for eligible counterparties and does not constitute advice.