- This guide sets out the basic principles of what needs to be considered by both an SME Owner & the Management Team. Each transaction is different which is why the appointment of Advisers is important
- Owner/ MBO Team negotiations need not be adversarial but this can depend on the experience & attitude of appointed advisers
- An MBO should NOT be confused with an Employee Ownership Trust transaction, where the latter has polarised opinion amongst advisers over the trade off between Owner tax advantages & risks of ever receiving the contracted Sale Price
- The text is relevant as at publication date of 1 February 2021, but the continuing level of volatility experienced in the SME business environment may change perspectives: prevailing tax concessions for SME Owners are on the cusp of changing in 2021/22
- Whilst the pressing issues of illness or divorce may dictate an urgency to sell up, ideally a measured approach for an Owner Selling his/her business will be more financially rewarding
- This is why Avocet introduced the 1 = 4 Increased Business Value programme in 2014 to help Owners plan their exit & remedy any perceived Value weaknesses, to achieve a better Exit Price
ABOUT AVOCET INVESTMENTS
- Avocet was established in 2001 as a Corporate Finance firm to help SME Owners typically in the 500k-£5m turnover range, with sourcing finance, business advice, & selling Owner’s businesses
- Over 20 years Avocet has sold over 50 businesses, including13 MBOs, across 29 industry sectors
- One client used Avocet for 2 Management Buyouts & an acquisition search before finally selling out to a PLC
OWNER EXIT OPTIONS
- TRADE SALE: whilst obvious this may not be necessarily appropriate. The size of transaction may be too small to attract interest or the sector may have no participant with the funds to proceed. Moreover an expression of interest may only be to extract pertinent information (although covered by a Confidentiality Agreement), or the buyer motivation may be to buy the turnover & strip out all costs including loyal staff.
- MBO: which will need a competent Management Team with an entrepreneurial spirit & capability for attracting funding. Often because of the challenge in raising the purchase price for the business, an MBO offer will not be the highest, with the price paid over an extended period. Over 50% of sub £2m t/o businesses are sold to MBO teams.
- COMPOSITION: does the team have the right skill set to be effective & is there a leader ?
- Skill Set: are the basics of Sales, Production & Finance covered, with the leader holding one of these positions. Dependent on business size, Finance beyond basic Credit Control & Invoicing may be outsourced to the Accountants for the business
- Numbers: it is important to keep numbers down & manageable
- Leader: this is not a badge but someone who commands the respect of the Team, the workforce & external advisers. In a small business this is often the hardest role to fill when succeeding a handson Owner with strict overheads control
- REASON FOR UNDERTAKING AN MBO: it is important for Team members to be honest with themselves as to WHY they want to undertake an MBO:
- To protect their job when risking money in an MBO is a very expensive & not without risk, method of Job Preservation
- To make some serious money when they eventually Exit the business through a Business Sale
- OWNER NEGOTIATION: the Team often finds itself uncomfortable & disadvantaged as current employees negotiating with their historic boss. This is where an external Adviser used to such situations can prove invaluable.
- MBO TEAM OWN EXIT AMBITIONS: it is important to understand who realistically the MBO Team will eventually sell out to. This will influence how they plan to run the business to make it attractive for that type of buyer
- THE PLAN: this is essential both to attract funding for the MBO transaction & as a discipline on the Team in how they resource & run the business when they own it. This is where an appointed Advisor can help.
- STRESS: undertaking an MBO can be very stressful in both achieving the transaction & in running the business - switching off is difficult & is certainly not the same as being an employee.A good Advisor will help in Project Managing the transaction.
PRICE & DEAL STRUCTURE
- WHAT IS THE BUSINESS WORTH: a cynically realistic analysis of the business is needed to assess:
- The Customer Base: is it loyal & are there any regular contractual arrangements
- Suppliers: how will they react, since many supply contract have change of ownership clauses
- The Competition: how intense is this, & are there one or two competitors asleep at the wheel
- Existing Product Range: how relevant is the existing & anticipated marketplace
- Cash Generating Ability: this is a critical area because in addition to attracting enough money to afford business purchase, a Team does not want to have continually find more cash to reinvest in the business, without good reason
- Level of Existing Debt: often the business will have historic debt, which should be attended to by the existing owner, leaving the Team as new owners a clean slate. If this is impossible, this must be reflected in a downward revision in the price paid for the business
- Recent Financial Performance: how well has the business been doing, what costs can be trimmed going forward, & can prices be increased. As a rule of thumb a Manufacturing business should have a Gross Margin of at least 40% & a Distribution business one of at least 30%
- Growth Potential: an honest assessment of why the Team will do better than the existing Owner is required. If the answers to some of the above questions are not good the Team should not be afraid to walk away from negotiation - others who may be interested in acquisition will find the same weaknesses, increasing pressure on the Owner to reduce his asking price
- EXTENDED TERMS:
- Deferred Consideration or Vendor Loan: this is the repayment of the Owner’s Loan to buy his/her business, which may extend over several years
- Performance Earnout: this is not a guaranteed amount but varies according to how well the business performs. This can create considerable risk for the current owner & can be the source of dispute in future years. If an Earnout is agreed, it is best to keep it simple - usually on Sales not Profit
- SKIN IN THE GAME: most funders will want to understand how much “risk money” the Team is putting into the transaction. Their not unreasonable attitude is “why should we risk our money if the team does not apparently have any confidence in the success prospects for the transaction”
- SOURCES OF FUNDS: there are many sources of potential funds for an MBO, beyond just a High Street Bank Loan. These will be covered in more depth in a forthcoming Avocet Information Guide on Sources of Finance, but below is a brief synopsis:
- Major Customer: dependent for valued supply continuity
- Major Supplier: requires MBO success for its own sales
- High Street Bank Loan: usually has to be property backed
- Equipment Re-Leasing: using financially unencumbered plant
- Invoice Discounting: Working Capital in a growing business
- Team Skin In The Game: second mortgage on a house
- SERVICEABILITY: in the pursuit of raising the money for business purchase, it is often all too easy to lose sight of how the debt raised will be serviced & ultimately repaid. Lack of serviceability can bring a business down.
- For arguably the most important financial decision of their lives it is vital that Team members seek appropriate professional advice
- CORPORATE FINANCE: experienced in successfully negotiating MBOs of their size, in terms of Price & Deal Structure, & who will help source appropriate funding. They will act as an important bridge between the Owner & the Management Team (who owe their livelihoods to the Owner & may not wish to upset him/her in negotiation)
- A SOLICITOR: who is equally experienced in completing MBO transactions for businesses of their size, & who arguably adopts a pragmatic approach to getting transactions done
- AN ACCOUNTANT: to avoid any conflict of interest the Team will need to appoint its own Accountant, both to help in advice on the transaction (including Deal Structure & Tax Advice), & then ongoing support, including possibly the production of monthlyManagement Accounts
- It is important for the Team to establish the scale of Adviser fees at the outset, to avoid any nasty surprises later
- In the case of CORPORATE FINANCE there should be a Proposal for it to review, detailing the Key Issues which might affect a transaction, what will be done on its behalf, & the fees which are usually structured in 3 phases. There are an Engagement Fee, a fee for reaching Heads of Terms which is the broad terms of a transaction agreed between the parties, which can then be worked up into Legal Documents, & a Success Fee for completing the transaction which is usually a fixed sum
- Any reputable SOLICITOR will discuss the potential transaction with the Team (at nil cost). Then a report highlighting what he/she believes has to be done & fee estimate, will be sent for the Team’s review & if acceptable, for their official Instruction.
- Similarly the Team should discuss & obtain a report with fee estimate from an ACCOUNTANT
WHY SOME MBOs FAIL
The principal reasons identified by experienced advisers are:
- Paying too much for the business
- Inappropriate deal & funding structure
- Composition of the Management Team
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