A request by the management team for permission to pursue a buy-out may seem harmless or even positive, but before you answer, it is vital to understand the likely ramifications. The buy-out may not be in your best interests, and even if it is, there is a potential conflict with the management team. So ground rules need to be established at the outset.
Before deciding on your reaction, you need to identify the alternatives — specifically, the likely deal value you could get from trade buyers.
Many vendors are over-optimistic when it comes to listing companies that could be keen buyers. They are even more optimistic about the value of the deal that could be achieved.
The best bet is to start with an analysis of the deals completed in the sector during, say, the previous 12 months. The multiple of after-tax profits reported is usually the basis of the valuation, but this may be misleading. A more reliable guide to the value that could be achieved can be based on the features of the company to be sold and the forecast profit for the current year and the following two years.
Financial modelling determines
the price a venture capitalist could afford to pay and still achieve its required rate of return on the investment. Generally, venture capitalists are making a stand-alone acquisition, so a trade buyer, which may gain a strategic advantage from the deal or benefit from combining its operations with those of your company, may be prepared to offer more.
But most trade buyers are not prepared to compete against a management buy-out team. The concerns are that they will inherit a demotivated management team, who may leave for other jobs or pursue management buy-ins elsewhere.
In fact, prospective buyers are likely to insist on meeting the management team before making a written offer, but while a meeting can be supervised, subsequent telephone conversations cannot. So there is opportunity for the management team to be downbeat about prospects to deter trade buyers.
Of course, sometimes no serious buyer will be identified, or only direct competitors. If so, this points in favour of a management buy-out.
One way to give the management team a chance to achieve a buy-out — but with you in control — is to give them just six weeks to obtain a specific written offer from a venture capitalist, on their own letterhead, at or above a given target price, based on the likely price that could be achieved from known potential buyers or venture capitalists.
The right target price
Avoid giving the management team a target price which cannot be met by a venture capitalist or a trade buyer. If a buy-out offer is rejected and subsequent attempts at a trade sale fail, the management team may seek to buy the business at a reduced price, in which case the vendor has lost a significant amount of cash — and credibility.
In most cases, vendors appoint corporate finance advisers at the outset. As well as giving objective advice on how easy the company will be to sell and the value it may fetch, they act as a buffer between vendors and the management team. This is vital, because emotions can run high and nothing will be gained from conflict.
Sometimes, where there is definite appetite from trade buyers and venture capitalists, it may make sense to run the process as a vendor-initiated management buy-out, often called a VIMBO. This is not just a play on words, but an altogether different process.
The vendor uses advisers to market the business to a list of private equity players to secure the best offers. The management team need only become involved in the decision-making process after one or more private equity players has shown an appetite to pay an attractive price.
The selected backers will wish to be comfortable with the team they are supporting, and will also wish to introduce to them a non-executive chairman or director whom they will undoubtedly wish to bring on board.
As these events unfold, the management team will effectively ‘change sides’ as their interests will lie with their new supporters. However, by orchestrating the VIMBO, this switch of allegiances is delayed until a firm deal has been agreed, and heads of agreement signed. This reduces the vendor’s risk compared to a traditional MBO approach, which can have conflict built into it from the outset.
To mitigate the possibility of any divided loyalties, you can reward loyalty and commitment on the part of the management team with a discretionary performance bonus, probably tailored to the deal value, payable upon completion.
This gives the team a ‘starter for 10’ with which they can purchase their equity stake in the acquisition vehicle, usually referred to as Newco. It also generates the goodwill required to complete the deal in harmony rather than acrimony.