Management buyout guide

 You've dreamt about it many a time but actually becoming the owners of the company you work for may feel a bit too farfetched. An MBO presents risk and stress, from executing the deal to running the business. It can start to become overwhelming, but it doesn’t need to. Here is our 101 on MBO’s:

First things first…is this right for you?

Does an MBO solve your problems at work? If anything, life is about to get harder before you reap any reward. So seatbelts on and brace yourself. There are a lot of cogs you need to turn before the wheels start to move.

Who’s in the gang?

MBOs typically involve more than one person covering the various bases from sales to operations to finance. You need to ensure you have a balanced and cohesive management team with the right experience and together hold a unified vision. Do not underestimate how important the team is. Yes, financial backers are looking for a good product and market but they are also looking to back competent teams with strong track records. Your team’s CVs are critical and will be scrutinised by investors and banks to assess credibility to deliver the proposed plan for the business. It’s also time to think about who’s going to be in charge. Whilst it will feel liberating to be able to express all your views as a management team, the buck will need to stop somewhere. All organisations need a pragmatic and capable leader at the helm with the authority to make the final decision. Be honest about whether you have the skills a financial backer is looking for …some will be critical and some may be those a backer is willing to help plug in after the deal.

What’s the plan, team?

You will need think how to turn that dream into a fully-fledged business plan to present to potential investors. But before you get yourself knee deep into this, first conduct a feasibility review to see if an MBO is even a viable option. Things to consider include:

• how much you think you need to offer the vendor;

• what is the profit and cash flow generation over the next 3 to 5 years;

• who are the likely backers to fund the acquisition, debt and equity structure;

• is there an exit plan for you and where is your equity value going to end up in 5 years’ time?

When it comes to putting together your high level numbers for the feasibility review or indeed when moving onto a detailed business plan you must ensure they are realistic and achievable. You will need to be clear about how much debt you can take on and still comfortably service the interest and repayments from your cash flow. You will also need to consider what level of equity is fair to give away to the funders to make it worth their while.

Any forecasts you put together must be your own, but start by looking at past numbers and then consider the market variables driving the future growth.

As you get further down the track of speaking to funders, you will need to put together a detailed operational financial model. That’s an excel spreadsheet detailing all your input assumptions and calculations outputting as profit & loss and cash flow forecasts.

Once you have your operational forecast numbers, you will want to overlay this with a funding structure to test out different debt and equity structures to see what the various outcomes look like for all the stakeholders. This may become a bit more complicated and technical than you can cope with so it might be a sensible juncture to call in the experts if you haven’t done so already!

Are you being realistic about vendor’s expectations?

Very broadly, vendors want the highest price with as much of the consideration paid out as cash on completion. They will likely hire an advisor to run a controlled auction process so you are going to have to move quickly and think how you can make your offer more attractive. But be careful to not push the bidding price up too much as this will ultimately push up your borrowing costs, lower your equity stake and reduce the number of financial backers that take you all the way to the altar.

Don’t forget you are in a unique position because you know the business better than outsiders. You know all the nooks and crannies and that is your key competitive advantage. Consider the vendors’ motivation for sale:

• Are they selling because of illness and want a quick sale?

• Do they really want to sell to their arch enemy competitor?

• Is the business a division of a larger business that is being divested because it has poor margins or is just non-core?

• You, as the MBO team, will know the business so may require less onerous warranties and indemnities than a trade buyer

Leverage all you know to get a best deal and use it wisely to inform you when to walk away if the price is too rich.

Who’s going to back you?

Unless you have a rich uncle, you are going to have to hustle. Luckily there are a plethora of equity and debt funders out there including banks, term lenders, subordinated debt providers, family offices, high net worth individuals, venture capital, private equity and vendor financing.

You will need to get your detailed business plan ready and put together a management presentation to pitch yourselves and the business. Depending on who the backer is and if they are providing debt or equity a different approach will be needed to address their specific requirements. As much as you need to put your best shoes on and show prospective funders your prettier side, it is also incumbent particularly with private equity backers for them to float your boat too.

You are going to have to work in close quarter with them for at least 3 to 5 years so be sure they are good fit for you and check they share similar or complimentary objectives and style of working. Definitely meet other investee companies to see how they really are so you are not duped into bed with them. With debt funders, your relationship will remain a little more formal so focus on the numbers and don’t overstretch yourself.

Another option to consider and growing in popularity is employee ownership trusts (EOTs) which often allow transition when there are family succession issues into a broader employee base. It is also a tax efficient way to exit the business.

How much are we in for?

So, yes you can get financial backers, but most of them expect commitment from the management team. Private equity typically expect you to at least commit one year’s worth of gross salary invested as “hurt money”, but adjusted to reflect particular financial circumstances. It is also common for the bank to provide loans to the management team to cover their personal investment. Whilst typically coming into the MBO, the management team will contribute the lowest percentage of the overall price with debt normally covering over half of the price and private equity putting up the remaining chunk as equity and loan notes, by year 5 the management team should own the largest proportion of value in the business.

A simple illustration:

For a business worth £30m today, it may be funded:

• £20m bank term debt

• £9m Private equity loan stock

• £1m as equity with the MBO team paying £600k for 60% of the shares and private equity paying £400k for the remaining 40%

After 5 years, the business has, for illustration purposes, grown to a value of £40m split accordingly:

• £8m bank term debt remains outstanding having paid £12m out of the cash flows of the business

• £9m Private equity loan stock still outstanding (although they will have had interest payments)

• £23m with the MBO team owning 60% of this at £13.8m

The rewards can be huge, but for an MBO to work it typically requires strong profits, mature cash flows to pay for the debt and growth opportunities in the market to make it attractive for equity funders.

Structuring the deal is a fine balancing act and will depend on the specifics of the business, the stakeholders involved and careful negotiations between each of them.

When is this all going to end?

As part of your evaluation of funders you are going to need to consider each of the stakeholders exit requirements and see if it aligns with your own exit objectives.

Most of your backers will likely want to be paid out before you see any money. It is prudent to assume bankers will not allow dividends to be paid out and your value will be locked in for three to six years.

Consider who controls the exit and whether you will need to do a secondary buyout as the initial equity funder exits and a new one enters for the next stage of the business growth. It could be you are looking to sell the business on to a trade buyer, or float on AIM or LSE. Whatever the exit plan is, you will need to groom the business into the right position.

In the meantime, you need to get cracking building on the goodwill of the staff, suppliers and customers so you have the best chance of succeeding. It is common for the MBO team to be joined by one or two experienced non-executive directors who can help steer you on your journey. Often these appointments will be made by the lead private equity investor.

Don’t give up the day job

From the initial feasibility review to closing the deal, there are numerous steps inbetween. The careful handling of vendor conversations, project managing the business plan, financial model preparation and negotiating with all the various financial backers to name a few. We strongly recommend using an advisor to help you navigate this journey.

During the process you will also need to ensure you get proper tax advice covering everything from tax clearances, utilising tax losses, capital gains tax and group relief on companies leaving a group, inheritance tax, stamp duty, VAT, income tax relief on loans, share options schemes, tax indemnities and warranties needed from the vendor.

Other areas to also get advice on may include employment contracts, employee incentive schemes, pension schemes, key man and other insurance. Trust us the list is bigger than this!

There is a lot to take on. The process is rarely simple and the negotiations will feel never ending.

Technical things aside, this is an emotional roller-coaster and you will need to keep you wits about you whilst ensuring you don’t fall short of your employee and shareholder duties. Your focus should be on running the business as any drop in performance may put off the same backers you had wooed.

But don’t worry….. we’ve got you.