Considering a management buyout? The key criteria you need to know.
For the business owner it is often a chance to retire or unlock the wealth tied up in their business. Whilst for management it provides an opportunity to gain direct equity ownership of the business they have helped grow. However, pursing a Management Buyout (MBO) can be extremely demanding. Andrew Craig, Partner at Maven, discusses the critical factors which both parties need to weigh up when planning to execute this complex transaction.
A management buyout can be an excellent solution to business owners who perhaps don’t have a formal succession plan in place and/ or would prefer the incumbent management team to take over the running of the business as opposed to selling to a trade acquirer. It goes without saying for a MBO to take a place there needs to be both a willing buyer (management) and seller (vendor).
There are a number of criteria that are considered to be essential for a successful management buyout with the key elements summarised below;
High quality management team – the most obvious and important factor for a MBO to be successful is that there must already be an experienced and harmonious management team in place who are committed to growing the business. Investors typically look for a balanced team of executives who work well together with all of the key areas covered, although it is normal for the board to be enhanced with the appointment of a Chairperson and/ or Non-Executive Director. The management team will also need to be able to present their strategic aims and plans for the business and how they expect to create value over the short to medium term (i.e. through organic growth and/ or by acquisitions).
Strong levels of cash generation with a demonstrable track record – the business needs to be able to demonstrate that it can continue to generate sufficient profit and cash to sustain the business as it continues to grow, whilst providing the required return for all shareholders and to support the on-going working capital and capital expenditure necessary to deliver the strategic plan.
Deal planning & execution – to achieve a successful deal the management team need to ensure that they have prepared in advance to deal with the numerous queries raised during the due diligence process. Once the outline terms of the MBO have been agreed between all parties, the funders, typically the PE sponsor and the senior lender, will need to undertake a thorough due diligence exercise to confirm their view of the business and to identify any issues that need to be addressed pre and post completion. Due diligence typically involves a number of work streams, including but not limited to, financial, commercial, management, legal, tax, IT, environmental and insurance.
How to fund & structure the deal – the total funding requirement will consist of the purchase price for the business, the transaction costs and any future working capital and/ or capital expenditure. The business must therefore be able to support the buyout financing structure from the cash it generates from its trading profits. Key to this is ensuring that an appropriate and sensible valuation is agreed by all parties at an early stage in the deal process. Agreeing on a valuation for the business is not an exact science. Patience and understanding from both sides is key. There are three key methods used to value a business being i.) market based valuations i.e. based on a multiple of earnings, ii.) net asset valuations based on the assets and liabilities on the balance sheet and iii.) discounted cash flows based on the future cash flows of the business.
The temptation for management is to seek to raise as much debt as possible and minimise any third party equity investment as typically this would allow management to receive a larger equity share, however this must be tempered with the benefits that a PE investor can bring to the business, both the equity investment and their expertise in growing businesses. While equity is more expensive than debt management and their advisers must consider all of the options available to ensure that the business has the optimal capital structure to help deliver the strategic plan.
To re-iterate here is a summary of the key points that need to be considered and addressed when thinking about undertaking a management buyout:
Consider all of the available options – prior to proceeding with a MBO it is essential that the vendor has considered all of the liquidity options available to the company.
Alignment of interest – both the owners and management should be clear on what their own aims and objectives are in undertaking a MBO to ensure there is alignment of interest from the start of the process.
Agreeing on the valuation – negotiating a fair and sensible valuation at an early stage is obviously key with the aim to strike the right balance between fair compensation for the vendor while ensuring that the new owners are not overpaying for the company.
Financing of the deal – consider the most appropriate sources of capital and avoid the temptation to take on too much debt.
Fail to prepare, prepare to fail - ensure that the business is ready to go through the due diligence and deal process. Look to engage professional advisers pre-deal if possible, as they can help project manage the process from start to finish.
Choose the right equity partner – it is important to consider not just the terms on offer but also the track record and sector knowledge & experience of the PE investor. It is also crucial that the chemistry is there from day one as the management team will be working closely alongside the PE investor.