Taking the pain out of a management buyout

Management buyouts may have slowed down in the UK over the past year, says Martin Griffiths, but high success rates have ensured it is still a buoyant sector

Over the years I have discovered there is only one guarantee when you embark on a management buy-out – it is going to be an emotional roller coaster for all concerned. As in any other business transaction, you have a buyer and a seller and at some stage in the process each will have doubts, concerns and stage fright.

So, is it worth it? The answer is yes in the majority of cases. The UK MBO sector is big business. Although the number of transactions has fallen in the past 12 months, the UK MBO market in 2000 was worth £20bn. That much capital cannot be wrong. People like MBOs because they have a high success rate for both the investor and management team.

The design sector presents opportunities for the would-be MBO team. Indeed, my own firm completed a third transaction in the past 12 months in the design sector, when we advised Kinneir Dufort on a successful MBO, which completed in February 2002. This transaction had all the necessary attributes for a successful MBO, namely:

An impressive management team

A clearly defined business strategy

A strong and defensible market position

Attractive growth prospects

Positive cashflows

So, if you are thinking about launching an MBO for a business that currently employs you, and you have a willing seller, where do you start?

First, make sure you get good, industry-wise advice. You will need a corporate lawyer and corporate finance advisor. Check their credentials carefully – do they have a successful track record in similar transactions? Are they people you can get along with and are they honest and direct about the proposed transaction? You are far better off being told the deal will not fly before you start rather than find out a couple of months and several thousand pounds in fees later – even if you do not like what you hear. Get them to address all of the above criteria.

Second, with your advisors (who should work mainly on a contingent fee basis) on board, table an indicative offer to the vendor, having assessed the financial position of the consultancy and its growth prospects. You cannot be precise at this stage because further information will come to light later that will affect the price.

If your offer is accepted you will be ready to prepare Heads of Terms with the vendor, which will set out the basic structure of the transaction.

Now, with the help of your advisor, you will need to compile a business plan, which will serve two functions. The first is to prove that the business is worth buying at the price struck. The second is as a tool with which to raise the required finance to complete the deal. In the latter case your advisor should already have discussed with you funding possibilities – the business plan is designed to sharpen up those thoughts and finalise the approach.

Once you have agreed the priceand have sifted through the financing options resulting in a formal offer of funding, the fifth stage comprises the legal, financial and commercial due diligence procedures. Your backers will require reassurance in all of these areas to satisfy themselves that there are no ‘show-stoppers’ – and so will you.

If you are still going, you then enter the sixth and final stage – contract negotiations and completion. These can take several weeks or months, but it is vital to remain focused as you enter the home straight. Do not concede points you have fought hard for earlier that are crucial to the success of the new venture.

And what about the seventh stage? That’s the one where shortly after completion you start your first day as your own boss with a massive hangover after a heavy night in the pub.

Or is that just my deals where that happens?

Different funding available for an MBO

Management equity – managers do not often have large sums of cash lying around. However, they are often asked to invest some ‘sweat’ capital as a sign of their commitment to the deal. Amounts vary, but you could be asked for as much as one times your annual salary

Venture capital – not easy to get hold of. In people-driven businesses like design consultancies, where tangible assets are thin on the ground, the management team needs to be first rate to acquire venture capital funding. For a team with the right credentials it is still possible to raise sums as low as £250 000 from this source or from the business angel community

Debt finance – most MBO’s will require an element of debt finance (a term that covers a large range of lending structures). In some cases the entire transaction can be funded from debt finance. The obvious appeal of debt funding is that the management can retain 100 per cent of the equity. However, against this there must be sufficient ‘headroom’ in the business plan to ensure the debt can be serviced in testing times

Vendor loan – this device is sometimes used to bridge any gap that arises between the amount of money needed to buy the business and the amount of funding the MBO team can raise

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