What is an MBO and how do you get one off the ground?

An MBO is where the existing management team buy the business from the current owners.

Before beginning the buy-out process it is imperative to assess whether there is a ‘deal to be done’? This would include consideration of the following:

• Will the current owners sell to the management team?
• What might the price be?
• Is the current management team up to the task?
• Are the cashflows sufficiently positive and predictable to allow finance to be raised?
• Can both parties make money on this and can they agree on the longer term strategy?
• Will your domestic life take the strain?
  

Having established a deal can be achieved, clear goals and targets should be set. This should not only cover the maximum consideration management will be expected to pay but should focus on the structure of the payment/s and whether the business is to be bought out completely or whether the owner is to retain an interest in the business for a pre-determined period.

Once a strategy is in place, a formal approach can be made to the owners. Assuming an agreement on price can be achieved, the preparation of a business plan can then take place which will detail how the deal will be structured and what external funding is required. This will be presented to potential investors.

Throughout the process, it is key that management continue to focus on running the business. However, they should not underestimate the time involved in an MBO process.

How is the current economic environment impacting on MBOs?

There is no doubt the most important factor affecting MBO activity in Scotland is the availability of finance and whether the market will return to more traditional funding in the foreseeable future.

In the past, the bulk of finance required to purchase a business via a MBO was normally provided by financial institutions i.e. banks, private equity investors etc. However, the recent financial crisis has had a significant adverse impact on the MBO sector due to the lack of available funding.

One way around this is for the vendor to negotiate a deferred purchase price, whereby a proportion of the total consideration is paid over a pre-agreed timescale, often linked to the future success of the business. This eases the pressure on cashflow and helps ensure the business is able to meet its debt servicing obligations. It is possible that, subject to conditions, this deferred consideration may prove to be tax advantageous to the vendor.

Whilst lack of available funding from financial institutions continues to be a significant barrier, there are still many advantages of an MBO, particularly in the current climate. One such advantage is the management team’s knowledge of the business. The MBO team will generally know the nature and resilience of the business, therefore they are much better placed to deal with the day to day operations rather than ‘new buyers’. This offers more assurance to customers, sellers and, importantly, providers of finance.

In addition, the MBO team is also often best placed to explain any issues that arise from the due diligence carried out by potential funders which otherwise may derail the deal.

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A few stats on MBOs in Scotland maybe?

As the acquisition and mergers market in Scotland remains, at best, fairly static, there is a growing number of ‘exits’ via MBOs rather than traditional trade sales.  This is reflective of the lack of finance available in the current market and also because potential buyers are faced with an uncertain future, including the problems of increasing inflation, unemployment and the security, or otherwise, of existing trade suppliers and customers.

It is a difficult time to sell a business and to maximise the value that has been built up over the years.  Increasingly we are seeing sellers having to lower their expectations as to price (as it is a buyers’ market) and, furthermore, it is often taking longer for them to receive the consideration.

MBOs are often the best option if an early exit is sought.  There are good ‘bargains’ available to potential MBO teams provided they are willing to take the risk of proceeding with an acquisition in the current climate and can secure external finance and/or vendor deferred consideration.  Another option to consider is the network of private equity investors who are willing to invest in good MBO opportunities.

The key factors in a successful MBO

• Quality team
  Funders often back the management team first, and the quality of the business second. A successful MBO team should cover all the essential skill sets (particularly finance), have a coherent vision and be able to demonstrate a proven track-record and market knowledge.  This should be allied with a will to succeed.
  
• Robust business plan
  A strong business plan demonstrates insight and imagination in addition to thoroughness It addresses the market and competitive landscape as well as market share. It should reflect the history of the business as well as its prospects, an achievable growth strategy with realistic projections and sensitivity analysis. It should also demonstrate understanding of a funder’s requirements for debt cover, capital growth and exit options.
  
• Earnings and cashflow
  The business must demonstrate a strong earnings stream, preferably without an over-reliance on a key contract or one or two customers . In the same way, the business must be able to generate predictable positive cashflow. Debt and equity funding will be very difficult to raise unless funders can see reliable cashflow to meet interest and repayment terms.
  
• Preparation
  Debt providers have different considerations to equity funders and each will have different styles and approaches. Preparation will help source the right partners, negotiate the best deal, have the best prospects of completing the transaction and, ultimately, making money.
  
• Get tough
  MBOs are exciting, but they can be difficult to deliver in the current market place and you, and your advisers, should negotiate hard to ensure you are correctly rewarded and incentivised. It is vital that an MBO team has good financial and legal advisors to manage the process ensuring it has as much time as possible to manage the business and ensure value does not diminish.

 

Stewart has advised on a number of MBOs both before and during the current financial crisis.

Over the last couple of years, it has become increasingly more difficult (but not impossible) to secure funding for MBOs.  Even the time taken to conclude deals is generally taking longer due to the nervousness of funders.

Gone are the days of a submitting a business plan to various financial institutions and helping clients select the best deal offered. I acted for an MBO team in Scotland less than two years ago and had to rely on my contacts with funders south of the border to secure the finance. Scottish banks simply did not have the appetite to finance the deal.

I am currently advising a young, forward-thinking management team on a potential MBO which is only progressing because the owners have acknowledged they will have to leave in an element of deferred consideration.  Whilst this is not an ideal position for the vendor, it does demonstrate their acceptance of the lack of available external finance and, indeed, their faith in the management team who have been instrumental in the recent success and development of the business.

There is no question raising finance remains a major stumbling block but I believe there are attractive opportunities currently available for dynamic management teams who understand the fundamentals of their business.

To assist in this, it is vitally important, an MBO team receives straight forward practical advice on how to structure the best deal to ensure the acquisition is attractive to potential funders and maximises their return on investment.

We are all adapting to the changing market and are facing challenging times. It is essential we take a common sense and flexible approach to sourcing and securing funding solutions.

Contact:

Stewart MacDonald, Partner