A management buyout is the combination of two transactions: the purchase of the business from the owner and the agreement between the team and the venture capitalists regarding an equity deal.
If the opportunity for an MBO arises because the management team has been directly invited to consider one, there will still be a turbulent few months for the members before they become the new owners.
It can be dangerous, however, to make an approach when no move has been made by the owners to dispose of a poorly performing business. Suspicions may be raised that the management team has deliberately engendered the organisation’s decline.If a management team wants to explore the possibilities, it should find a corporate finance adviser to assess the feasibility of the project and make an anonymous approach to the company on their behalf to discover whether a sale would be considered.
If the answer is ‘No’, careers have been protected as nothing has come out into the open. If the team has been so fired up with enthusiasm that the members really wish to own their own business, they should go elsewhere.
Assuming an MBO becomes a viable option, it is essential that the team includes the senior director from the existing business, preferably the managing director, who is unquestionably the key player. However, all members of the top team must demonstrate commitment to the deal. They will have personally to invest up to £25,000 in order to be taken seriously by the people who will be putting up the cash for their equity investment — the venture capitalists.
They may have to take a second mortgage, or cash in other assets, so this does not just affect them as individuals, but also their families.
The management team would typically comprise managing director, sales & marketing, operations director, technical director, and a finance director. If a key position remains unfilled, most corporate finance houses have access to registers of interested and suitably experienced executives.
Teams have to recognise that venture capitalists invest in three things: management, management and management. The business sector is secondary to the quality of management.
In the first few years after the buyout the generation of cash is more important than the profit before tax. Cash provides additional working capital for sales growth and capital investment to keep pace with technology and bring in additional funds to repay some of the debt and overdraft that has been used to finance the buyout.
The correct choice of venture capitalist is essential. There are many who provide finance, but a corporate finance adviser will assist the team in making an informed selection of three or four venture capitalists who will find the size of the transaction and the business sector attractive to them. Part of the advive package will be to ‘pre-sell’ the opportunity, so that when the business plan is submitted, the chances of an initial meeting are high.
Something like 70% of all business plans submitted to venture capitalists by prospective management buyout teams are rejected without the team even getting a meeting. Only around 2% of business plans result in an equity investment being made. A shrewd corporate finance adviser will ‘groom the team’ for this meeting to create a favourable initial impression.
Venture capitalists want to deal with management teams who are hungry to work harder than ever for the next few years, to realise a substantial capital gain. If they sense the real motive of the management team is to ensure their job security, the venture capitalist will run to the hills.
The amount of equity offered, and the purchase price venture capitalists are prepared to pay for a business will vary significantly. Advisers will negotiate the purchase of the business, and maximise the percentage of the equity stake the management will receive in return for their investment.
There will be a requirement to appoint a non-executive chairman or director, who can bring relevant business and sector experience, to give a wider perspective to the team, and, ideally, valuable personal contacts.
From a timing point of view, there have been examples of MBOs having been completed within three months. These are the exceptions — typically the deal will take five to six months to bring to fruition, and will prove a long, arduous roller-coaster ride, usually culminating in a nail-biting seven days. It is not unusual for there to be eleventh hour negotiations with both the owners and the venture capitalists over amendments to the purchase price or conditions. A typical scenario is where more equity has to be provided by venture capitalists because the amount of debt envisaged could not be raised on acceptable terms.
However, many such deals do ultimately go through, and MBO teams embark on a road which should lead them — if all goes well — to demonstrable business success.