Managementbuy-outs

As a manager in a business you areprobably looking for your next challenge.Are you interested in owning your owncompany? Do you have some great ideasabout improving the business you workin but feel constrained?Being a manager puts you in a good position within your current business to be in line forownership when your current employer retires, and this could be sooner than you expect.

Alternatively, you may own a company and be thinking about long term plans for yourbusinesses future. Are you wondering who will continue the business when you’re ready to retire, or do you have a non-core part of the business which you would consider selling? If this is the case it may be worthwhile considering your current management as the newowners. It could potentially be a far less traumatic sale than to external parties and provide an opportunity for your management and employees for the future.

If you are in either scenario it is a realistic option for management to buy the company theycurrently work in. This transaction is commonly known as a management buy-out (“MBO”).

What are you looking for?

PAGEo2

An MBO, by definition, is thepurchase of a company by itsmanagement. Managementwould generally acquire acontrolling or significantequity stake for a smallpersonal investment. Theremaining purchase price isfinanced by external partiesproviding debt and additionalequity.

MBOs first came to the UK market during the 1970s. Since then they have increased inpopularity to become the most commonform of acquisition today. The graph to theright demonstrates that MBOs generate, onaverage, 50% of all merger and acquisitiontransactions.

It is a common misconception that onlycertain sectors fit the MBO model. In realityall types of business lend themselves toMBOs. The chart to the right illustrates thebroad spectrum of industries that MBOtransactions have occurred in the last 5 years to 2008.

What is an MBO?

PAGEo3

0

10

20

30

40

50

60

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006%

70

2007 2008

Transport &Comms 3%

Property &Construction

5%

Food &Drink 4%

Healthcare 4%

Other9%

TMT11%

Paper, Print& Publish 4%

Manufacturing27%

BusinessSupport andFinancialServices 21%

Retail &Leisure12%

MBO shareof TakeoverMarketSource: CMBOR

5 yearaverage MBOSectordistributionSource: CMBOR

If you are currently working in a managementrole but with no (or limited) shareholding inthe business, by taking the next step andinvesting a relatively small amount of moneyin an MBO transaction, you could stand tosignificantly increase your personal wealth ina short period of time. A bank or funder willsupport you financially for a number of yearsbut once the finance is repaid you will havegained an equity value in your own businessfor a small investment.

The graph to the right depicts an MBO dealwhere the business is worth £5 million at thetransaction date. Management are requiredto invest only £200K, the remainder of thedeal is funded by debt of £3.8 million anddeferred consideration of £1 million. As thevalue of the business increases under newownership and the debt is repaid, the valueowned by the management increasessubstantially. After 5 years the business in theillustration is worth £14 million, all the debt isrepaid and 100% of the business is owned bythe management. Therefore, after a £200Kstake and 5 years’ work, the managementhave made 69 times return on their initialinvestment. Even if the business didn’t grow,managements’ value would still yield a 25times return for the MBO team.

What are the benefitsof an MBO?

An MBO also provides youwith job security. If youremployer sold to an externalparty the new owners mighttake the decision to replacemanagement with their own team.

Commencing an MBO transaction may,however, put strain on your relationship withyour current employers and they may feeluncomfortable divulging sensitive companyinformation to you. This process needs to bemanaged with the assistance of externaladvisors. You will also need to put 110%effort into the venture to convince funders ofyour commitment, as well as having adefined strategy for continuing the growth ofa profitable business which can meet its debtrepayments and has a healthy future.

PAGEo4

0

2

4

6

8

10

12

Day 1 Year 1 Year 2 Year 3 Year 4 Year 5£m

14

16

Debt

DeferredConsideration

ManagementEquity Value

More than likely, you will be suffering from anumber of doubts as to your capabilities inrunning a business of your own. This iscommon as an MBO is a big step to take. It is important to be confident in your team’sabilities and to convince funders that you arethe right team to provide financial backingto. You may want to ask yourself thefollowing questions:

• Are you and your team sufficiently experienced?

• Are you committed to seeing the transaction through?

• Do you have a clear vision or strategy to take the business forward?

• Will you be able to step up your role in the business in respect of dealing with staff and other stakeholders?

• Are you able to access some personal capital to invest?

In addition to looking at yourself and yourteam, you should also decide whether thecompany is a viable business going forward,does it have good prospects and are yourplans going to improve its current tradingposition further? What are the risks facing thebusiness and do you have a strategy toaddress or mitigate these?

Can I reallyrun my ownbusiness?

PAGEo5

PAGE o6

This is one of the most critical aspects. A strong management team in a weakbusiness is arguably a better bet than a great business being taken over by a poormanagement team.

You will need to demonstrate that your teamis more than capable of running and growingthe business, i.e. has the right spread of skillsand necessary experience. A typical MBOteam is made up of the following elements,usually consisting of 3-4 people:

• Managing Director• Finance Director• Sales Director• Production/Operations Director

If you can’t cover all these aspects it may bepossible to fill the gaps with an externalcandidate. Your advisor may be able to helpfind the right person. The above team is alsonot prescriptive. The key is to involve allsignificant members of management and thiswill vary case by case.

TheManagementteam

The major issue concerning managementteams at this stage is how they are going toafford to acquire an established businessthemselves. It is important to note, however,that the MBO team will only be required toinput a relatively small portion of the overallconsideration. The main reason you are askedto put your own capital in initially is to showyour commitment to the deal. This iscommonly known as “hurt money”.

The remaining consideration often comprisesbank debt in one form or another. It is one ofthe cheapest forms of financing but requiresrepaying prior to any other financial providerand will have strict terms attached.

Deferred consideration mayalso be introduced. This iseffectively where the exitingshareholders lend back to thecompany a proportion of theconsideration for a period.

Financing thetransaction

Venture capital (“VC”) funding is anothercommon option (usually alongside bankfunding) for financing the purchase price. A VC will assist companies by injecting cashin return for an equity stake. They have amid-term plan of typically 3-5 years, wherethey aim to increase the value of their stake(as well as yours) and ultimately exit througha number of possible routes. They will usuallyappoint a member of their team to yourboard to assist in decision making andstrategic direction. They do not, however,take any direct part in the day to day runningof the business.

In order to obtain funding from financialinstitutions you must have a detailed and wellthought-through business plan for success.

To measure this, funders will invariably focuson three key criteria:

• A strong and well-balanced management team.

• A commercially viable existing business. • A sound and developed strategy for the

future.

All of the above areas need to be presentedto chosen financiers in the correct mannerthrough both the business plan and effectivemeetings with funders.

1 Assessing your chances and the ‘sounding out’ process

At an early stage the MBO team should bechosen and soundings taken by the teamleader as to whether the team has anappetite to get involved.

Alongside this a high-level approach to thevendor should be made. This needs to behandled sensitively and the response judgedas to whether there is in principle a possibledeal to be done.

At this stage, if there is a willing vendor,outline discussions may take place on value.At this point, if not earlier, it is imperative totake independent advice from a corporatefinance advisor.

The process:

PAGE o7

PAGE o8

2 Your Advisor

You should appoint a corporate financeadvisor as soon as possible to assist youthrough the deal. Their fees will often be on a part-contingent basis, and thevendor/company may be prepared tounderwrite some of the costs. Costsassociated with an MBO transaction willhowever be built into the overall fundingrequired.

Ensure your advisor has the right credentials.Try to find out what deal experience theyhave in your sector and whether they areexperienced in MBO transactions. This mightinvolve obtaining testimonials.

Your advisor will talk you through every stageof the MBO process and assess whether yourplans so far are viable. They will provide anindependent, secondary opinion and assist inmaximising your chances. They will ensurethat what you present to the vendor andfunders gives you the best possible chance ofsuccess. Your advisor will also ensure the dealis structured in a manner that is commerciallyviable and advantageous to you in terms ofthe correct funding structure and minimisingrisk.

Moreover, an advisor will be able to approachthe vendor on your behalf, know the righttime to approach them and negotiate withthem to obtain the best deal for you and onethat the vendor is happy with.

An experienced advisor will have many MBOdeals under their belt and this experience iscritical to managing the emotional roller-coaster ride to completing a transaction. The advisor will:

• Provide an independent view on valuation.• Add credibility to funding proposals.• Prepare you for meetings with funders.• Negotiate with vendors and finance

providers on your behalf.• Assess the reasonableness of all

commercial terms.• Agree an appropriate financing structure.• Project-manage the entire process.

The process (continued):

PAGE o9

3 Agree terms with the Vendor

Once you know your MBO team arecommitted and the vendor has agreed toconsider an MBO, it is now time to approachthe vendor seriously and negotiate the termsof the deal.

Let your advisor lead the negotiations. Youshould reiterate your goals and aspirations toyour advisor prior to any negotiations, so theyare clear on what you definitely want toachieve and areas you wouldn’t mind givinga little on. Your advisor will consult you atvarious stages throughout the negotiationsbut if they have a clear picture of your goalsfrom the outset they will be able to workmore effectively.

Approach negotiations with the aim ofreaching a mutually beneficial solution forboth parties. Those who go in with a bullishattitude will more than likely just cause majorstumbling blocks along the way and break

down the existing relationship. Always keepyour own goals in mind. Try not to befastidious on elements that don’t concern you too much as, if you give a little in certainareas of importance to the vendor,negotiations will remain harmonious which is critical.

An imperative tool innegotiations is remainingcomposed. Emotionaloutbursts will distract bothsides from the task in hand.

It is also important to be strong duringnegotiations and, if the other party are notplaying fair, then have the courage to walkaway from or at least reconsider the deal.

Always bear in mind that should negotiationsfall through you may need to revert to yourexisting management roles, which is whysome degree of harmony in negotiations isimportant.

PAGE 10

5 Locate your funding

Once you have a business plan you will beable to engage in dialogue with fundingproviders. Your advisor will be able to giveyou advice on an appropriate fundingstructure for the MBO. Your first movetypically will be to speak to your currentbankers to see if they will be interested insupporting you.

This will be the simplestoption, as the bank willalready know your history and your business.

It will also be worthwhile approaching someother funders, in case they can provide youwith better terms. Your advisor will be able toassist you in determining active andappropriate funders in the local market.

6 Perform rigorous due diligence

This phase of proceedings will allow you todelve into the inner workings of the business.Whatever your involvement in the businessprior to the MBO, inevitably you will havebeen excluded from some aspects of thebusiness. This is now your chance to checkeverything is in working order and that youare paying for what is actually there.

Due diligence for an MBO party may not beas meticulous as for an external buyer, as youalready know the business. But remember it isthe funders who are taking the lion’s share ofthe risk and they will need to be satisfied withtheir investment. For this reason, externalfinancial and legal due diligence will becommissioned by them.

The process (continued):

4 The business plan

Despite knowing the business and its currentowners very well you will still be required toprepare a business plan in a professionalmanner. The business plan will be your sellingtool; it will portray your future plans for thebusiness, show your understanding of thecurrent business and its markets and how youplan on making any necessary changes. Youshould be selling your vision to potentialfunders in order to secure support for thedeal.

As soon as you obtain clearance from thevendors to pursue the MBO you should agreeheads of terms and an exclusivity period toarrange finance and then commence work onthe business plan. Your advisor will assist inpulling the document together and ensure itcovers all necessary areas, but you will needto write the majority of the content andprovide detailed financials for your advisors togenerate forecast models to substantiate yourplans. It takes a lot of effort to create a goodbusiness plan but it will prove to be essentialin the early stages of the deal, as well asproviding you with some structure goingforward. It also, importantly, enables youradvisor to critique your plans before beingput in front of the funders.

PAGE 11

The whole process can take around 6 months(and generally a minimum of 3 months) sobe prepared to be fully committed to thetransaction for that time frame. This can itselfbe very challenging, as you will also be doingyour normal day job running the businessand keeping it on track.

As soon as the deal goes through you shouldfirstly advise your staff and reassure them ofwhat the future holds under your ownership.You should then inform your suppliers andcustomers of the change in ownership andseek opportunities to get some positive PR.Forward planning will enhance the prospectsfor this to be successful.

Your ongoing task is to ensure that your plannedchanges are implemented and followed through toensure funding constraintsare met and the business sets off on its new coursesuccessfully.

Concluding thetransaction

YorkArabesque HouseMonks Cross DriveHuntingtonYork YO32 9GWt: 01904 464100f: 01904 464111

ManchesterPeter HouseOxford StreetManchester M1 5ANt: 0161 602 3250 f: 0161 602 3251

NewcastleCuthbert HouseCity Road, All SaintsNewcastle-upon-Tyne NE1 2ETt: 0191 350 6155 f: 0191 350 6156

LeedsStable CourtBeechwoodsElmete Lane, RoundhayLeeds LS8 2LQt: 0113 273 9600f: 0113 273 9601

web: www.garbutt-elliott.co.uk

mo

ded

esign

.tv