Colin Burns is a Director in our debt advisory team and an expert on funding Management Buyouts (MBO's). In this article Colin looks at the recent high trend for MBO transactions and shares his knowledge of how they can be financed.
Management Buyouts (MBOs) remain high on the agenda for many companies. Over the past few months, we have received numerous approaches to assist with funding MBO transactions. So what is driving this level of activity and will it continue?
As owners’ personal circumstances change, retirement might now be appealing for a variety of reasons and perhaps the value created within the businesses will provide the retirement ‘nest egg’ to enable this lifestyle change. Having seen off several recessions and a global pandemic, now might be the right time to cash the chips in.
We have also seen some businesses struggle during the pandemic whilst others rise to the challenge. Those that have managed to succeed, potentially pivoting into new lucrative markets, might sense an opportunity to monetise the value.
Legislative changes, particularly in Capital Gains Tax (CGT), can also be a driver in seeking an early exit. It is fair to say that we believe the recent (pre budget) rumours that CGT changes were going to be introduced, potentially penalising owners’ gains on business sale proceeds, had some effect on current MBO and trade sale levels.
Although the Chancellor appears to have kicked this particular can down the road, it remains an area which will no doubt have his attention in the months and years to come. With all this in mind, I fully expect MBO activity to remain vibrant for the foreseeable future.
When owners start to think about how they might extract value, a trade sale is an obvious exit route. This can often maximise the price, and usually result in the majority of value being available for immediate distribution to the vendor on completion.
However, trade sale options are dependent on a number of factors. Certain ‘in-vogue’ sectors can generate much larger multiples especially if they are considered a strategic fit for the buyer, have long term recurring revenue streams and are already of scale. Unfortunately, not all businesses have these features and may not therefore be attractive to potential purchasers.
While there are other routes which may be considered, the most common is offering the business for sale to existing management. This is not without some challenge as it can be a complex transaction and the vendor will likely have to ‘support’ the deal with an element of the sale price deferred for a period.
An MBO is an extremely delicate transaction. It places the management team and shareholders in the opposing camps of buyer and seller. If handled incorrectly, an unsuccessful transaction can have a long- term negative impact on the business.
Similarly, if done properly, it will provide the owners with an elegant way of extracting value while passing the baton (and future equity uplift) to the management team who were very likely a key component in the success of the business and probably the best team to take it forward onto the next stage of its evolution.
"Present a credible management team to potential funders."
An MBO needs a clear leader in the management team. While agreeing on who the CEO should be and making sure they are strong enough is not an easy task, it is something that must be done well before an MBO is realistic. It is important to be able to present a credible management team to both the market and potential funders. The likelihood is that this will be their first MBO transaction (and probably their last) so getting it right first time will be critical for success.
The amount of distraction such a process can cause should not be underestimated. Key management still have their ‘day job’, while trying to juggle this with negotiating a good deal. This often creates tension between the MBO team and owners and having a corporate finance adviser who is able to act as a ‘circuit-breaker’ can alleviate much of this stress while helping negotiate and structure a deal which is both acceptable to all parties, and crucially fundable.
A management team will rarely have the financial resources to buy the target company, but will need to make a meaningful financial contribution often referred to as ‘hurt money’. ‘Meaningful’ is defined in the context of the individuals personal worth but needs to be a material contribution to ensure any funders have confidence that the management team are fully motivated to deliver against plan.
It is also important to have a realistic and detailed business plan with management team fully bought into the strategy and forecasts. This is key as it will be these numbers against which funders / investors will monitor the business with failure having potential consequences. Understanding these consequences will help to determine whether the risks being assumed are acceptable from both a company and personal perspective.
"Professional advice and support materially de-risks the MBO process."
It’s unwise for either a business owner or a management team to broach the subject of an MBO without fully understanding how to complete the transaction. Professional advice and support materially de-risks the MBO process.
An MBO is a transaction in which a company is purchased by management using their own cash resources, debt, external equity, vendor roll over (deferred consideration), or a combination of each. It is one of the most complex transactions that can be considered.
Financing MBOs can also be tricky as lenders will need to consider a range of scenarios from an affordability perspective as there is likely to be little by way of tangible security to offer a lender. They are inherently riskier lending propositions and funders will need confidence in the management that they are the right team to take on the business and deliver on a credible business plan. There may also be a requirement for financial and commercial diligence to provide additional comfort that what has been presented is a fair reflection of the of the business and its prospects.
Traditional high street bank funding for these transactions has rapidly diminished in recent years. Fortunately, the alternative funding market has stepped up to fill this void and sculpt loan profiles over a much longer term. This means an increased level of affordable borrowing can be secured, based on capital repayments being stretched over longer periods, enabling a higher level of cash to be extracted on day one by the vendor.
However, navigating the myriad of alternative lenders to ensure the business secures the best possible funding package is an art in itself and particularly time consuming. We always suggest seeking expert advice.
At Shaw & Co we provide a turnkey solution to assist management with deal negotiation based on market knowledge of multiples and common transaction features, while simultaneously sourcing the best possible finance package in a seamless service.
With the ever-evolving alternative finance landscape, you would be well advised to explore what the wider market has to offer. A good adviser will run a competitive process to deliver the most cost-effective deal with the most appropriate debt structure.
My colleagues and I are often called upon to act as a “circuit breaker” in the negotiation with a historically dominant owner. We scrutinise the business plan, present the company to the funding market in the best possible light, manage the expectations of all stakeholders and quickly take the heavy lifting off the MBO team, allowing them to ensure the company doesn’t lose business focus during the process.
If you are part of a management team considering a management buyout, please do not hesitate to contact us for independent advice.
When the owners of a market disrupting brand had the opportunity to buy their business back from Vodafone, they asked us to make the deal happen.
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