Every business has an exit plan, there are a number of options but have you considered a management buyout? I would like to share my experience of supporting a company through the experience which took six months.
The company, which I will call “ABC Co” had been established in the 1970’s as a service provider to the book printing industry and publishers. The owner took the opportunity to manufacture a higher quality product and provide outstanding customer service. He had created a niche in an expanding market, his business was successful and had grown steadily.
The founder enjoyed a good standard of living from his hard work. However, it was a capital-intensive business in a sector where technological advances were accelerating. It was necessary to continually re-invest to stay competitive. This involved raising significant financing and this came with onerous security arrangements in the form of personal guarantees. The owner began to tire of this cycle of borrowing and providing security and began to think of selling his business.
Implications of a business sale to staff
The business had five main production departments, all managed by long-serving staff. As the owner looked at how the business might be sold, he was anxious to ensure that any new owners looked after his managers. Despite initial discussions with several interested parties it became apparent that there would be no absolute guarantees of his manager’s positions post-sale.
The owner confided in his managers about his retirement plans and concerns, they were also worried about the implications of new ownership under a business sale. So they worked together on a management buyout. ABC Co had accountants but the owner was keen for his manager to receive impartial advice and made an introduction to me as a member of FinanceHeads.
Although the owner was keen to sell to his managers and was happy to discount his ideal price to enable a deal, the capital-intensive nature of the business meant that funding was problematic due to insufficient capital contribution and security-grade assets. The main asset for each of the managers was their family home and these were already subject to mortgages.
Funding a Management Buyout
Funding was a major obstacle to completing a management buyout (MBO). However, the need for further additional funding by a new inexperienced management team made raising the working capital and finance for the ongoing Capex needed, seemingly impossible.
As their FD I divided these problems into smaller chunks to make them more manageable. This is the process I followed to arrange the MBO funding:
- The starting point was to prepare some projections to assess the viability and capital repayment capacity of the company going forward.
- It was agreed with the owner that a significant element of the purchase consideration would be deferred.
- The putative management team were then introduced to a specialist mortgage broker to explore the options for re-mortgaging their houses.
- Offers were sought for asset-based funding assistance to re-finance the plant and machinery, and to use confidential invoice discounting to raise cash from the debtor book.
- An application for funding under the Government’s Loan Guarantee Scheme was made, which could provide finance when there was a restriction on the normal levels of security available, in return for paying a fee for the Government to secure the bank’s advance.
- Discussions were held with a number of venture capital firms to assess their appetite for providing equity and loan capital.
- Introductions were made to potential funders and solicitors experienced in MBOs.
- Initial planning for managing the business post-buyout commenced and it was agreed that they needed my ongoing support as their Financial Director whilst the management team got up to speed with the financial and commercial aspects of running a business.
There was now a plan and a degree of excitement and optimism amongst all involved. It became apparent that all parties were determined to make a MBO work.
Overcoming stumbling blocks of funding an MBO
As the various parts of this complex MBO jigsaw progressed, the issues and challenges began to surface.
The owner’s solicitors advised that his deferred consideration should be reduced in size, secured and carry some return. As their Financial Director I negotiated with the solicitors and agreed that the amount of deferred consideration would not change. The owner’s outstanding balance would be represented by loan notes which included an interest rate, participation in future profits by way of an earn-out provision, and the security of a deferred debenture
Negotiations were now needed with the other potential funders to agree on this principle of a deferred security for the vendor.
Re-mortgaging all the management team’s houses to 95% loan to value would be possible but this introduced the issue that, largely due to age differences, each manager had differing amounts of equity in their properties. This would result in each of them contributing a different amount of capital but they had already agreed on an equal 20% ownership. Eventually it was agreed that this was possible as their capital contributions would remain as loan accounts in the company and out of future dividends they would try to equalise all the loan accounts. The managers nominated the eldest manager as the potential MD and leader of the management team. Things were progressing well.
It was also agreed that the owner’s shares would be purchased by the company on behalf of the management team and that they would be investing in a new share issue. This meant complying with the rules around the provisions of “Financial Assistance” to a company buying its own shares and rearranging the company secretarial matters to accommodate both the share buyback and the new share issue. There was plenty of work for the solicitors to complete!
The asset-based lending part of the process was the easiest element to arrange as several lenders were keen to be involved. Specialist machinery valuations were required but the debtor book was well spread largely to blue chip companies and therefore, a relatively easy matter for the confidential invoice discounting line to be set up.
After submitting detailed projections in support of the funding request the Loan Guarantee application was successful. It helped that I had used this scheme several times before with NatWest so there was both familiarity with the process and a successful track record.
Although there was interest from several providers the management team agreed not to proceed with the venture capital element.
Here’s to a successful buyout
The MBO process took six months from the initial idea and was toasted with champagne upon completion. ABC Co owner received his deferred consideration and the loan guarantee scheme advance was repaid in three years. The management team grew in experience and capability as I worked with them as their part-time Finance Director for one day a week.
Is a Management Buyout right for your business?
To get you thinking, start by asking yourself these four questions:
- Do my management team have the skills to lead the business and uphold the values I created?
- How will you fund it – invoices, equity and/or a loan?
- Have you got enough working capital to grow?
- What skills are your management team lacking to make your ongoing business success sustainable?
I hope this real-life example of a management buyout helps you understand what’s possible. As you can see there’s a lot to consider, not just funding, so if you’d like to talk this through with your own Finance Director and discover the implications of a management buyout for your business please contact Michael Cartwright.