How to conduct a management buy-out
Article Date: May 07 2009
Philip Marsden, MD, Vantis
If your company is facing the prospect of administration (or worse), it could still be rescued by a management buy-out (MBO), writes Philip Marsden, MD of Vantis Corporate Finance.
The bad news is that it’s not going to be easy, and will demand serious commitment from the management team wishing to buy into the business. The good news is that now may be the best time for MBOs for a decade, particularly if the business is part of a larger group.
Preparation
An MBO typically takes at least three months to complete, but could run to six. The first task is preparing the business plan, with the all-important detailed financial projections for the first three years. These need to be in the form of integrated trading, cash flow and balance sheet forecasts setting out all assumptions used and the reasons for them, and stress tested for worst-case scenarios.
The plan must demonstrate that the business can afford the desired funding package and can meet any restrictions placed on it by the funders. Usually, there will also be a 100-day plan, stating exactly what will be done. This is particularly important if the business is in distress and being bought out just before or after insolvency. The “new” company must be able to produce timely and accurate monthly management accounts and short-term cash projections, in order to underpin funders’ confidence in the MBO team and their forecasts.
Price
Successful smaller businesses are typically being valued at a multiple of 2.5 to five times current operating profit, or EBIT (earnings before interest and tax), or two to four times current EBITDA (earnings before interest, tax, depreciation and amortisation). This latter measure equates to operating profit plus add-back of depreciation and is considered a proxy for cash flow.
The actual multiple will depend on the size and growth potential of the business, risk factors, the state of its sector, and the relative importance of the management team to the business. Businesses in distress are typically valued at a substantial discount to net assets.
Funding
The main stumbling block, of course, is securing funding. But the current success we are having in funding MBOs (with four completed in the last seven months and one more in the pipeline) suggests that financiers are still supporting deals they believe in if they are well planned and presented.
MBOs are usually funded by a combination of equity and debt. Debt takes many forms and is tiered according to the security available to the lender and interest cost: the better-secured the funding, the cheaper the debt. Total debt funding available to a business can be up to 2.5 times current or expected EBIT or EBITDA.
Equity finance includes the management’s own contribution, which individually could be a year’s salary. But the total contributed by the team is more important. Also, the vendors may make personal loans to the individual team members.
Other equity funding sources may be private individuals, suitable private equity funds and the vendors themselves. In difficult lending markets, it is common for vendors to bridge the funding gap by rolling over part of their consideration, either in the form of a loan, perhaps paid as an ‘earn-out’ against achievement of a pre-agreed profit target, or as a retained equity stake.
Finding equity and debt funders, plus completing their due diligence investigations, can take around three months. But if a business is in distress, there may not be time for this, so either funding will either have to come from incumbent lenders and backers, or a specialist turnaround investor.
TIPS
Do:
– Prepare a robust business plan with three-year forecasts and assumptions
– If the business is distressed, draw up a detailed 100-day plan of action
– Assess the skill set of the management team and seek any necessary additions
– Consider the team’s importance to the company and how this may affect the price
– Ensure there are no black holes or unacceptable risks in legal documents
Don’t:
– Pay too much – negotiate the initial price down if you have sufficient importance to the business, and remember the advantages of an MBO to a vendor
– Lose the trust of your current owners – they will refuse to sell to you!
– Be unrealistic in the business plan about future risks and prospects, particularly if the business is distressed – plan for the worst case
– Lose heart – the road can be long but worthwhile in the end
Vantis is an AIM-listed accounting, tax and business advisory group.
