When looking to exit, a business owner has a number of options. One of these is to sell the company to the existing management team. A sale to management may be preferred to a trade sale for a variety of reasons, for example, the number of potential trade buyers may be limited, the vendors may be nervous about approaching competitors and disclosing sensitive information or they may feel strongly that the company and its staff carry on independently in what they believe to be “safe hands”.
In its simplest form, a management buyout (MBO) involves the management team of a company combining resources to acquire all or part of the company they manage. Most of the time, the management team takes full control and ownership, using their expertise to grow the company and drive it forward.
For a company undergoing a change in ownership, the MBO route offers advantages to all concerned. Most obviously, it allows for a smooth transition of ownership. Since the new owners know the company, there is reduced risk of failure going forward, other employees are less likely to be concerned and existing clients and trading partners are reassured it will be “business as usual”. Furthermore, the internal changes and transfer of responsibilities between the vendors and management remain confidential, while any due diligence required by funders is often handled quickly.
The strength of the management is a critical factor in contemplating the potential future success of the company. Therefore, any funders pay close attention to the skills, experience, knowledge and credibility of the management team as well as their vision for taking the company forward. And while the management team can reap the rewards of ownership, they have to make the transition from being employees to owners, which requires a change in mindset from managerial to entrepreneurial, and all parties need to ensure this is a transition that is achievable.
Funding an MBO
Of course, for an MBO to be successful, vendors must be willing to sell the company at a realistic price and with a fundable deal structure. It is rare that a management team will have sufficient funds on their own to buy the company and external finance will be needed, so MBOs are usually funded via a combination of sources:
- Management contribution – while they might not be able to fund the whole transaction, the management team is usually required to introduce personal funds, to provide confidence to a funder and to demonstrate commitment. A rule of thumb is one year’s salary but funders may be flexible on this depending on the perceived risk of the transaction.
- Asset finance – via leveraging against the assets in the company, usually, property, stocks or debtors.
- Bank debt – in additional to asset finance, banks will often also provide a cashflow term loan, repayable over three to five years to support an MBO.
- Private Equity (PE) – this in an increasing source of finance even at the smaller end of the market, with many funds looking to back management teams to scale their company.
- Vendor loan notes – if all the above is not enough, often the vendor can help fund the transition and leave some of their consideration in the company as loan notes to be repaid over time.
So what makes a successful Management Buyout?
- A company with a good track record of profitability
- Good future prospects for the company without high risk factors
- A strong committed management team with a mixture of skills
- A vendor who is willing to explore a sale to the management team and who will accept a realistic price
- A deal structure that can be funded, and supported by the future cashflows of the company.
And what about the risks?
There are a number of risk factors that can make an MBO more difficult:
- A strong dependence on the owner who is exiting
- The impending retirement of other senior management
- High customer dependence issues
- Market threats such as new competition or new technology.
Such risk factors do not necessarily mean that an MBO is not possible, but they need to be considered from the outset as funders will only provide support if they are satisfied that the company will be viable for the foreseeable future.
The MBO process
The key steps of an MBO process include:
- Buyer and seller agree on a sale price, possibly including an independent valuation.
- Management team assesses the amount they are able to invest.
- Detailed financial analysis conducted, including building a forecast financial model to show the serviceability of debt and returns to potential investors.
- Approach to funders, a small buyout may involve just one funder while in the case of larger transactions, several funders may handle the financing.
The MBO process can take around 6 months, about the same as for a trade sale, so the vendors and management team must be prepared to fully commit to the transaction for that time frame. This can be challenging since the company must be run as normal and kept on track while the transaction is on-going.
See also: Ten steps to a successful buy-out – Spectacular returns can be achieved through an MBO. Nevertheless, some deals could well end in failure due to basic errors in judgement.
On balance, an MBO may offer a vendor an attractive alternative to a trade sale. In considering an MBO a number of considerations need to be made such as the desire and credibility of the management team buying the company, the availability of funding and whether all parties involved can agree upon the funding mix. If all the boxes can be ticked the MBO route can provide a vendor with assurance of the future success of their company and the management team with significant opportunity to benefit from future successes.
Tom Allen is the assistant manager at Price Bailey Corporate Finance.
Investor appetite for management buyouts on the rise
Desire for management deals hits five-year high, according to a report by Lyceum Capital and Cass Business School
Analysing private equity investments with an enterprise value between £10m and £100m, the Lyceum Capital and Cass Business School UK Growth Buyout Dashboard reveals that the volume of transactions increased by 12% over the year, with 87 investments totalling £3.43bn (2014: 78 investments totalling £3.38bn).
Total deal volumes remain 30%-40% below the highs seen before the financial crisis, but the recent increase appetite for deals is expected to continue in 2016 with investors focussing on companies’ earnings quality and growth potential.
The majority of investment activity took place in the second half of the year, as the uncertainty leading up to the General Election subsided. The value of acquisitions in the £25-75m range grew 52% to £2bn year-on-year, an indication of improved investor confidence in established businesses that want to accelerate growth.
The number of investments in the business services and industrial sectors increased 84%, and 66%, respectively year on year, underlining the UKs longstanding strength in these sectors. Meanwhile, investment in the healthcare sector contracted by 33% in 2015, (from 6 deals in 2014 to 4 in 2015). This is a clear reflection of the concern businesses and investors alike have about reduced Government spending and the significant impact the National Living Wage will have on costs from April.
Despite the value of private equity acquisitions in retail and leisure businesses contracting by 33% to £866m, the figure is high compared to other sectors. While UK consumer spending is considered to be relatively robust, investors in the sector are likely to continue to be highly selective through 2016.
Commenting on the findings, Andrew Aylwin, partner at Lyceum Capital said: “It’s a seller’s market at the moment with private firms looking to deploy some of the largest cash piles in years.
“In a global economic market plagued with uncertainties ranging from falling commodity prices to volatility in the Far East, it is encouraging to see that the outlook for entrepreneurs and medium sized companies has never looked stronger. We expect these businesses to continue to attract increased amounts of investment and grow into industry champions over the next 12 months.”
See also: How to complete a successful MBO