MBOs may be a more attractive option than at any time since the early nineties. A quick scan of the business press from the past few months confirms that deals in the leisure and hospitality sector are completing. Jonathan Perrin and Philip Marsden from Vantis, the UK accountancy, tax and business recovery and advisory group, explain why the next 12 months could well present ambitious management teams in this sector with the opportunity of a lifetime.
Unrepeatable opportunities will arise during this downturn for management teams currently running businesses on behalf of individual owners or larger parent groups to embark on their own MBO. At the right price, with the right funding package in place, and the right approach to the current owners, the success rate can be high and the upsides enormous. This could be the once-in-a-lifetime chance for a strong management team to take control of the business they have helped to shape.
Finance is clearly still available for the ‘right’ deal: in the past few months we have seen
investor led buy-outs of Fishworks Plc, Apple Pan Holdings (t/a Eds Easy Diner) and MBOs of Alphabet Bars and Kalron Foods (t/a Zumo Juice Bars).
MBOs are most suitable where:
The business is
- part of a larger group – which is distressed or heading towards administration
- a non-core subsidiary of a larger group
- facing succession issues and the owners are needing an exit
- subject to dissent between shareholders
- a small public company which is better suited to being taken private
- owned by senior management and their private equity backers, and some or all are happy to be bought out by junior management
The management team is
- ambitious and willing to step up
- central to the business
- proven and has gained the owner’s trust
- capable of being supplemented by additional team members or Non-Executive Directors where needed
Pros and cons of an MBO in the current climate
For the MBO team, the major plus in the current market is of course that the cost of the business is likely to be at its lowest point in years. MBOs are being done at values equal to a substantial discount to underlying asset value, in the case of distressed companies, and at multiples of expected profit before interest and tax of 2, 3 and 4 times, in the case of profitable companies.
For the vendors, the prospect of selling to a team they have worked with and know well is far more palatable than selling to competitors and having to disclose highly sensitive information to them. They will not need to give nearly such rigorous warranties and indemnities to the MBO team and so the legal aspects should be easier. It should also be much quicker to agree a deal with an MBO team, and, in the current environment, it is by no means certain that trade buyers would be interested. As MBOs offer a degree of flexibility, the vendor shareholders can retain a stake in the company if they wish.
The major stumbling block for MBOs is currently, not surprisingly, raising funds. But, evidence suggests that funders are still supportive of deals that they believe in, provided they are well thought through and presented. For businesses in the leisure and hospitality sector, there are often assets such as freehold property which can be used to secure borrowings.
In many ways, an MBO is the ideal building block for rapid growth in this sector. Indeed, for those who have found a winning formula or theme, an MBO can be the first step to accelerate the roll out of new outlets.
Preparing for an MBO
Taking between between three and six months to complete, an MBO requires serious time, effort and commitment from the management team and its advisers.
The starting point is the business plan, which must contain detailed financial projections for the first three years (integrated trading, cash flow and balance sheet forecasts, ‘stress tested’ for worst-case scenarios). A ‘100 day plan’ is also useful, setting out key milestones post-completion.
The projections must demonstrate that the business can afford the funding package even in a `worst case’ scenario. If necessary, additional managers may be introduced, either as interim or permanent team members.
Other preparations include ensuring that:
- all legal documentation is immediately available and there are no `black holes’
- there are no ‘change of ownership’ clauses in customer or supplier contracts or, if there are, that consents can be obtained
- leases are in order, particularly ‘full repairing leases’, and that landlord consents can be obtained
- onerous contracts, leases, or creditors, or any down-sizing of the business, can be handled together with all associated costs, particularly where the business is in distress
- surplus assets can be realised in a difficult market
What is the business worth?
We are currently seeing successful smaller businesses typically being valued at a multiple of anything from 2.5-5 times current Earnings Before Interest and Tax (EBIT) (which equates to operating profit), or 2-4 times current Earnings Before Interest Tax Depreciation and Amortisation (EBITDA) (which 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, and the specific risk factors associated with the business and its sector. Distressed businesses are typically valued at a substantial discount to net assets, because the assets are not earning a return and there are risks associated in restoring the business to full health.
If the management team is instrumental to the business, they could dissuade other potential buyers from bidding and/or offer a lower price. This must be handled carefully so as not to lose the trust of the current owners or infringe the terms of contracts of employment. Legal advice will be required.
Funding options
MBOs are typically funded by a combination of equity and debt finance. Equity finance includes the management’s own contribution and investment from others.
While a manager’s contribution matters (as a rule of thumb, a minimum might be one year’s salary), it is the total contributed by the team which is more important. Usually, the greater the proportion of the equity requirement contributed, the greater the equity percentage they will hold versus the other investors. The management team can expect to be incentivised by ‘sweet’ (or ‘sweat’) equity in addition to that for which they subscribe cash, acknowledging the enormous effort they will be committing to the MBO.
Total debt funding available to a typical business tends to be in the range of up to 2.5 times current/expected EBIT or EBITDA.
The total of debt facilities available will determine how much equity is required on top. In addition to the equity from the management team, other sources may be:
- private individuals
- private equity funds
- the vendors themselves who might `roll over’ part of their consideration, either in the form of debt (loan notes), or perhaps paid as an ‘earn-out’ against achievement of a pre-agreed profit target, or in the form of a retained equity stake.
Seeking a full equity and debt package takes time - presenting to and seeking offers from equity and debt funders, and undertaking due diligence investigations. However, a ‘debt-only’ package should be quicker, provided there is adequate asset security available.
Finally....
Do
- Take advice early!
- Prepare a robust business plan
- Assess the skills of management
- Consider your importance to the business and the effect on price
- Ensure there are no black holes in legal documents
- Prepare a `100 day plan’ – particularly for distressed businesses
Don’t
- Pay too much - remember the advantages of an MBO to a vendor
- Lose the trust of your current owners
- Be unrealistic about future risks and prospects
- Lose heart - the road can be long, but the outcome worthwhile
A shortened version of this article was originally published in AQC Magazine on 1 June 2009.
The full length article was published in 2 parts in the October and November editions of En Passant Magazine.