Ask the Expert with Steve Plaskitt – Can you own your business?
Steve Plaskitt, our Corporate Finance Partner, shares his expertise on management buy-out and succession.
Business owners often ask if there’s a chance they could exit their business and allow management to succeed them. Managers can also be keen to find out if they can buy out their bosses.
The replies to both are similar – make sure that you have a deal acceptable to both parties that can be funded, and a plan to attract the funding. It is only then that the vendor should decide to stay with the business and continue to drive it forward, or to go and allow management to take over.
Similarly, large international corporates are increasingly looking to divest their underperforming business units and focus on their core businesses. Occasionally it is the local management team that can spot an opportunity for them to buy the business which they know would be very profitable when freed from the group. The first thought is often how can they raise finance for the MBO. This is because they will have become accustomed to the purse strings being a head office responsibility.
In both cases, once the decision has been made that management may explore an MBO and bid for the business, they must quickly become up to speed with how to value their business, how to structure their offer and where to raise the finance. This is where the role of a Corporate Finance Adviser is critical.
MHA Tait Walker recently advised on such an MBO – Nick Oates acquisition of Fabricom Offshore Services. This won the best deal below £2.5m at the North East Insider Dealmakers Awards in September.
There should be consideration of the vendor’s minimum valuation price along with the existing debt of the business. This is the enterprise value that needs to be funded for the deal. The enterprise value should be compared to the existing profits of the business.
EBITDA is commonly used as a comparison, as this is the closest estimate to cash flow generated by the company. EBITDA means earnings before interest, tax, depreciation and amortisation.
However, in some industries where continual investment in capital expenditure is required, then this measure of profits often overestimates the level of cash available to service debts. A good rule of thumb is that an enterprise value that is 3-4 times EBITDA is serviceable. For larger, faster growing businesses with profits over £1m this multiple could increase. Like all rules of thumb, it is a guide and needs accurate financial planning.
Once there is a valuation calculation, the next step is to consider how this can be funded:
- New equity: available to a business with great management and a good plan showing growth
- Debt: requires a business plan that shows the ability to repay the funding from current levels of trading
- Non-cash consideration: typically, the extraction by the vendor of a business property to their own pension scheme, or the extraction of cash built up in the business before sale
- Deferred consideration: a way for the vendor to fund part of the deal if there are no remaining sources of finance. Such deferred consideration could be a fixed amount or an amount dependent upon future performance
For MBOs initiated by the vendor, they should first consider with their adviser whether management could construct a deal on the above basis. They should also assess how likely it is to be funded before approaching management and offering them the opportunity of an MBO.
You should take care and allow room for the working capital required to achieve growth in the business plan. You should not use all your available funding on the deal. This may make it impossible for the business to quickly find alternative support in the event of an unexpected downturn in trading.
If these numbers don’t stack up, the vendor should sit down with management to plan how to grow the business. This is to ensure that an MBO would be a more achievable option at a later time.
For MBOs from large corporates, if the numbers don’t stack up, management should speak with group management. They should seek to persuade them that they are still in the best position to buy the business quickly, but only at a lower price which they can afford and which may be below the traditional valuation. The Group may still find this attractive. Like the saying “shy bairns get nowt,” you may find that you have secured a very good deal!
If you’d like to discuss MBOs or succession with Steve in more detail, please contact him on 0191 285 0321 or email firstname.lastname@example.org.