Management buy-outs provide an opportunity for courageous executives to raise the stakes and drive change.
There comes a stage in every company’s lifetime when a fresh approach is needed to add impetus and accelerate growth.
The management buy-out (MBO) is a time-honoured way of achieving this, and in the lower mid-market at any rate these deals are increasingly prevalent. Data from the Centre for Management Buy-out Research for 2011 shows that buy-outs in the £10 million to £100 million range totalled 81, with a value of £2.7 billion, an increase on both counts from 2010 figures of £2.3 billion from 69 deals. That’s despite an overall decline in mid-market M&A activity over the same period.
A step back
The decision of an MD or founder to take a back seat is a typical driver of these deals, and this was behind the buy-out of Leeds creative agency Intermarketing, which saw two of its client services directors, Steve Sowden and Jamie Allan, take control of the business.
Sowden explains: ‘We had started to bring some new ideas and direction, along with some new clients. Jamie and I had talked about the MBO for a couple of years, pretty much since he joined the company.’
When looking for backers, the duo were quite firm about who (and most importantly who not) to partner with. ‘We really didn’t want venture capital or private equity backing as we didn’t want them to have a say in how we ran the business,’ says Allan.
However, getting a bank on board was ‘a real struggle’, Allan adds. Despite adjusting the business strategy and exposing it to more sectors in order to spread risk, the MBO proposition was falling on deaf ears once it reached the credit teams.
‘It kind of contradicts the government’s efforts to get banks to lend to growing businesses,’ Allan states.
In the end, Allan and Sowden secured backing from a surprisingly local source, Yorkshire Bank. Remaining independent, away from private equity and venture capital influence, allows them to make the important decisions, the two say, without the pressure of multiples and exits.
Securing a deal
In stark contrast, when it came to finding a new equity backer for security business CSL DualCom, managing director Phil Hollett says that private equity was always the route that the business would be continuing with.
‘We are in the fortunate position of knowing how private equity works as we have been involved with it since 2006,’ he says.
Having joined the business in 2004, after spending a year as a frustrated shareholder, Hollett was part of the team that led an MBO of the Greater London-based company in 2006 through a deal with Octopus Investments.
Leading a second MBO of the company was a lot easier, Hollett admits, having spent the past five years becoming what he refers to as ‘private equitised’.
Through its most recent deal, a £32 million transaction with Bowmark Capital, the management team at CSL is providing what it describes as a ‘ringing endorsement’ of the business by investing fresh capital alongside its new private equity partner.
By taking out a new mezzanine finance line, in a move to avoid traditional bank debt, the team has invested with Bowmark and will have no debt repayments for at least five years.
Restricted aspiration
On reflection, Hollett admits that when CSL started out on its track towards its second MBO, he had his eyes on a higher valuation than the business eventually achieved.
‘At the time, the debt market closed off and private equity ended up acting as bank and equity partner. As soon as that happened, the premiums you expect to get reduce dramatically,’ he explains.
Leading a second MBO often means that management teams are more adept and experienced at flushing out the best backer and making sure that the terms of the deal are favourable towards them.
It also represents a different stage of growth, with the business already structured in the way a backer expects and comfortable with the idea of that backer influencing strategy and decision-making.
Midlands Industrial Glass first went through the MBO process in 2005 when venture capitalist Midven invested. A second MBO last year, backed by Key Capital Partners, enabled one of the directors from the first deal to exit.
Alan Taylor, managing director at Midlands, adds: ‘The first five years [of investment] were to grow the business and stabilise it. We invested probably £3 million to £4 million over that time to move into markets that are UK-dependent with short lead times.’
Taylor says Midlands’ revenues are growing by 10 to 15 per cent a year, having recovered from the step back that the business took in 2005 when it cut away some of its non-profitable work. ‘We are in a position now where we don’t have any bank debt and there’s cash on the balance sheet,’ he adds.
With the Key Capital deal, Midlands now has the ability to make some much more aggressive moves within its sector. The business plan that the private equity firm has agreed will see investments of £1 million a year on new machinery as well as opportunistic bolt-on acquisitions.
Having been at the business since before the first MBO, Taylor outlines the main difference: ‘We have more sleepless nights, but we are less stressed. The reason for that is that we can now do something about issues as the owners.’
Backing the management team
MBOs are popular with private equity backers because the management team has a solid track record of running the business. Research from Lyceum Capital shows that among private equity deals of between £10 million and £100 million in the past two years, there have been 105 MBOs, compared with 50 deals of other varieties (secondary buy-outs, management buy-ins and public-to-private transactions).
The same research shows that technology, media and telecoms (TMT) was the high-flying sector in the lower mid-market during 2011, contributing almost a third of all deals during the 12-month period.
IT company Selection Services has enjoyed a number of years of strong growth which have culminated in its management team leading a private equity-backed buy-out of the company.
Having spent 16 years at the Kent-based business, managing director Grahame Harrington says the deal came about due to the existing chairman’s wish to retire and exit the business. However, pushing the deal over the finish line was not easy going, and was a process first started two years ago.
‘We had a couple of false dawns through that period when we thought we had found the right partner but the deal didn’t work out in the end,’ he explains. Ultimately, Selection Services received backing from mid-market firm Palatine Private Equity. Looking forward, Harrington says the MBO will allow the business to develop in a manner dictated by strategic considerations, not by cash flow.
Finance finder for an MBO
For many, the traditional route through an MBO is to seek a private equity sponsor or to finance the deal using conventional bank debt. However, in an era when neither financing route is as easy as it was, alternative forms of capital have emerged as ways to complete buy-out deals.
East Kilbride-based shopfitting company Nabco Scotland has undergone an MBO with capital provided by RBS through an invoice discounting facility. Jim Millar, managing director at the company, says that while the business has always been relatively strong, the recession brought a dip in performance and meant that the time was right for a change of ownership.
The secret to securing backing for the deal, Millar adds, was convincing the lender that they were the right team to take the business forward.
‘We have been really hands-on with the business since day one so they knew that we knew the company, and more importantly how to run it properly.’
Having completed the deal, Millar and business partner Alex Perrie, director at Nabco Scotland, each hold a 50 per cent stake in the business as the two look to expand the company’s product range and develop markets that wouldn’t have been considered under the previous owners.
Millar initially became involved with Nabco in 2001, when he established the Scottish business on behalf of its St Albans-based parent company. His industry experience meant that he was able to bring with him a number of high-profile customers as he looked to build the new venture.
In taking control of the business, Millar explains that they had the full backing of their customer base, some of whom even wanted to invest in the buy-out. On top of that, the MBO has given sales a fillip. ‘The deal has meant that we’ve had coverage everywhere, which has encouraged some old customers to come back to us,’ he adds.
Millar’s admission that the MBO of Nabco Scotland has helped to increase customer interest demonstrates how leading a buy-out of a business can not only provide a new injection of working capital and industry expertise but also bring a sense of renewed vigour to a company.
The route towards ownership and control may be more circuitous and difficult than it used to be for management teams, but the destination is as appealing as ever.
