How to complete an MBO: Successful successions

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MBOs provide a fantastic opportunity for management teams to get a taste of acquisition activity in a familiar market. Mike Pawson gives guidance on how to ensure the deal runs smoothly.

For the past two years, the lack of deals activity across most major UK sectors, including the insurance industry, has been blamed on the credit markets seizing up. However, there are signs of a merger and acquisitions thaw inspired, at one end, by the Cadbury/Kraft merger but also within the insurance industry, there is an expectation that consolidation will return to the broker market.

The opportunity to embark on a management buyout (MBO) often comes about when a retiring owner opens up the door for others to follow in their footsteps, or when a group decides to sell off non-essential subsidiaries. At the other end, there are 'sellers' that might not even be in the market to dispose of their business but, faced with a sensible and serious offer from a committed management team, could be tempted to get the ball rolling.

An MBO presents a good opportunity for management teams that want to test the entrepreneurial waters with a ready-made business in a familiar market. It also allows the seller to reward loyal employees who know what they are buying from the outset, and alleviates the need to pass on sensitive trade secrets to potential competitors.

Putting the right team together is the foundation of a successful MBO. Banks and investors are increasingly focused on the strength of new business propositions, but are equally interested in the structure and skills of the management team - not to mention willingness to burn the midnight oil to make it a success. When it comes to securing the funding to get the project off the ground, a team boasting depth and breadth in management skills combined with industry experience and expertise will seem a good proposition.

The key for buyers is not to jump the gun on funding and due diligence until they know that the vendor is actually interested in selling the business. Once an initial feasibility study has confirmed that an MBO is in fact a suitable vehicle, and the buyer has an idea of the value of the businesses, they can present the idea to the owner or shareholders. Putting the cards on the table at an early stage allows everyone time to structure and communicate the succession.

Unless transactional expertise is already present in the management team, it would be wise to seek professional guidance at an early stage and consult experienced legal, tax and finance advisers along the way. Going it alone could become a costly lesson.

Drafting a business plan is one of the cornerstones of an MBO and will be crucial in securing the best possible funding deal. It is a vehicle for showcasing the strength and experience of the management team, illustrating how their business acumen will inspire growth and secure a safe and healthy return for investors or lenders. It is also a good idea to appoint a project manager, potentially a professional adviser, who will coordinate the process through to completion and help knit together the best deal.

There are a number of ways to structure an MBO, including one where the management team simply borrows the money to buy all the shares personally. However, the most popular and tax efficient vehicle is to set up a holding company that then borrows the required capital to buy the shares of the target company. The holding company would then be able to issue corporate bonds or subordinated loans to the outgoing shareholders as a deferred form of payment if full consideration is not provided by the bank.

Financing an MBO is usually a choice between or a mix of bank funding, venture capital and private investment from the management team. Aside from the usual suspects, there are a number of specialist lenders with a constant eye on potential investment opportunities.

Outside interest
Investors and banks in particular will expect to see realistic projections illustrating how the debt - both capital and interest - will be serviced. Historically, modest levels of collateral were asked of brokers but these days, management information such as up to date cashflow, profit and loss forecasts and balance sheets will be required. Brokers need to ensure that systems are in place to record and produce such information easily.

In the absence of collateral and personal guarantees, the bank will apply certain covenants that set out, for example, that the company's profits will have to exceed both capital and interest on the loan at all times. Any such arrangements must be adhered to, otherwise the buyers might be forced to repay the loan or agree to much less favourable conditions at short notice.

Although the deal usually hinges on the management team's ability to secure funding, inviting 'bids' from a range of sources could help get the best value for money without throwing everything but the kitchen sink into the deal. An MBO is a great vehicle for both the buyer and the seller in providing a comfortable exit for one party and a readymade business for the other, so neither party should be afraid to negotiate. It is in everyone's interest that the deal is successful, which provides some bargaining power. For example, if the bank has agreed to provide £1.3m of a £1.5m deal, the buyer could seek to find a compromise where the balance becomes a deferred loan from the vendor or is provided by external investors. Management teams willing to share the risks by throwing personal investments into the mix will have a greater deal of options open to them and will reassure lenders and investors.

Regardless of where the money ends up coming from, buyers must ensure that they know exactly what return investors expect and at what level they will be involved in the management of the business.

Comprehensive and expensive due diligence is rarely necessary for the management team that already possess in-depth knowledge about the business and its finances. However, lenders will insist on carrying out their own processes, which the management team should expect to pay for.

It can be a good idea to write a short-term three-month or 100-day plan with immediate actions and goals to make sure the new business gets off to a flying start. Telling clients and staff of the deal at an early stage might be perceived as potentially compromising the business, but leaving it too late can leave a vacuum that can be quickly filled with rumours and uncertainty. Gently introducing the management team to key clients and contacts would, where possible, be a sensible step to keep everyone onboard, maintain momentum and drive the new business forward. News of the deal might itself drive new business opportunities so take advantage of the press and get key messages out into the market straight away.

Mike Pawson is partner at Crawfords Accountants

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