Frequently Asked Questions or Misconceptions
How do I finance the deal?
A whole industry of venture capitalists, business angels and specialist bank teams exists to assist management teams buying businesses. In practice, any deal is funded by a mix of certain of these elements sometimes with the assistance of a loan from the vendors back to the business. In short the common misconception that you need to be a millionaire to buy a business is not true. You will however need to invest a certain amount of your own money alongside these finance providers as a measure of your commitment to making it work. This element is known as “hurt money”. Your adviser will assist in structuring the finance in the best manner for the individual scenario.
How much will I personally need to invest?
A typical rule of thumb often applied is a figure of one year’s salary. This will be invested alongside other funders to meet the overall acquisition price agreed for the business. The amount required is however negotiable with the funders and will be considered in the light also of the overall debt/equity mix in the deal.
Management buy-outs and buy-ins are “risky”
This is not necessarily true. A well-structured MBO takes account of possible shortfalls in performance and ensures that the business can still meet it’s financing obligations in terms of repayment of debt and interest and dividend requirements of any equity investors. Nevertheless, it is almost always the case that the new business following the MBO/MBI will have a greater debt burden and so will be more risky in terms of having less margin for error going forward. A management buy-in is typically more risky than an MBO as the management team have not had prior experience of running the business. These are accordingly harder deals to fund.
Do I have the right team in place?
There is a common saying that goes along the lines of what are the three most important things in any MBO or MBI – the answer “management, management and management”.
An experienced and balanced team is critical not just to the funding of the deal but critically the future success of the business. At an early stage therefore, the completeness, quality and balance of the team should be considered. The team should cover off all key aspects of the business with a senior leader (e.g. Sales, Operations, Finance, Purchasing) and should itself be led by a Managing Director. The funders will expect the team to have a clear strategic direction for the business and a range of development ideas that should provide growth opportunity without exposing the business to significant downside risk.
MBO teams cannot compete with trade buyers
Experience shows this is not true. There are a number of reasons why an MBO offer may be more acceptable than an offer from a rival firm. These can include management’s ability to act quickly, a paternalistic sentiment to pass the business down to management and to protect against possible job cuts or other changes that may arise under the ownership of another company. There is also a less onerous legal position for the vendor by way of reduced warranties and indemnities compared to a trade buyer, that may be attractive. A trade buyer only really has an advantage if they can afford to pay a higher price due to profit benefits arising from the combination of the two businesses.
How much will the company cost to buy?
The team should take advice at an early stage for an experienced Corporate Finance professional on this area. There is a significant range of valuations seen in this market with private companies being sold for anywhere between 3 and 8 times earnings before interest and tax on a debt-free basis.
An appropriate value will take account of size of business, sector, growth prospects, future cashflows and capital investment requirements amongst other factors.
How long will the process take?
Depending on the length of time spent in negotiations on price or structure, an MBO or MBI transaction can take anywhere from four to six months to complete. Why so long? Because there are a whole host of issues and matters that need to be covered both through independent due diligence undertaken by financiers and lawyers and a raft of legal documentation. Your adviser will however have been there many times before and it is important to utilise their expertise in project management as you still have the day job of running the business alongside the process!
Are there any sectors unsuitable for these transactions?
Not really, every sector has a track record of such transactions over the last few years. However, there will always be sectors that are more or less favoured at any time principally driven by the growth opportunities or otherwise relevant to those sectors and perceived risks in the markets. These will in turn affect price and the ability to readily fund such transactions.
Should I consider getting venture capitalists involved?
There are a myriad of misconceptions that centre around the private equity market and a general concern as to the role they have in the business. In practice whilst VC funds will appoint a non-executive director to the Board they will leave management in charge of running the business. Venture capitalists can bring a wealth of experience and contacts also which may be useful to the business.
Whether to get a VC involved is however usually a function of whether their investment is required to do the deal or whether the deal can be funded from alternative (less expensive) sources. A private equity fund will be looking for an annual rate of return on their investment of typically in excess of 30% per annum Compare this to bank funding rates and it can be seen to be an expensive source of finance. This return is principally derived from an assumed exit value relating to their required equity stake in the business and so it goes without saying that with VC’s involved management’s equity stake in the business is diluted. Sometimes however, the deal can either not be done without it, or the benefits in terms of potential further follow-on investment mean that this route is worth considering.
Finally, and most importantly – how do I make money from an MBO?
Whatever your ultimate equity stake in a business, there are three key ways to increase it’s value. First is to grow the profits, second is to repay the debt used to purchase it (every £ repaid from ongoing cashflows equates to a £ more overall equity value) and finally sell the business for a higher multiple of profits than you paid for it. The greater the scope to do all three the higher the return will be for management equity holders. There are plenty of stories of multi-million pound returns being made on relatively small management investments, but of course there is always the chance of losing your investment money.