Buy well, trade well, sell well

When a company decides to sell off a non-core subsidiary or the owner of an SME wishes to sell up, it is sometimes the case that a sale to the existing management of the company is the best option. Management buy-outs (MBOs) have been around for a long time and can offer significant advantages over a sale to a third party.

These include the speed of the process. The existing management already knows the company intimately and negotiations on price and so on can be concluded very quickly. Furthermore, selling to the management means a company doesn’t have to divulge commercially sensitive information to competitors, whose real interest may just be in gaining this information rather than actually going through with the purchase of the company.

Another advantage for sellers is the option of not having to sell all of the company. “If you own a high-growth business but don’t want to surrender it all, an MBO can be an attractive way to take some equity off the table but keep some skin in the game,” explains Deloitte corporate finance partner Anya Cummins.

"You can hold onto 40 per cent, 50 per cent or 60 per cent of the business and exit over time. The former owner becomes an institutional investor in the business and benefits from the second sale when the company has a higher value five years down the line. But you have to be very careful how you structure the investment to ensure it is pari passu with other investors and the value of the investment goes up and down with that of other shareholders."

Attractions for the buyer

There are also clear attractions for the buyer. The fact the management knows the business very well means they have a very good chance of making a success of it after the deal. They also know what to pay for the company so there is little chance of them saddling themselves or the business with unreasonable levels of debt.

The recovering economy has led to renewed activity in this area, according to BDO corporate finance partner Katharine Byrne.

“There is a lot more activity in the market now,” she says. “There are not as many deals as you might expect to complete but the economy, the availability of funding, and valuations have all improved. There might not have been the confidence among management teams to do it over the past two or three years but it is returning now. Owner-managers are looking to exit their businesses and the new environment allows both them and management teams a lot more flexibility to realise objectives.”

EY corporate finance partner Graham Reid also sees positive signs in the market. “Every year, EY does a divestment study and the latest one showed that 50 per cent of participating companies worldwide expect to divest a business. Seventy per cent of them were looking at divestment to fund growth. This should offer some opportunities for MBOs and is very positive.”

“We have done six MBOs over the past 18 months including Elvery’s and Ardmac,” says Capnua executive chairman Paul Keenan. “The important thing is for the management team not to get bogged down by the details and get distracted by the process. Advisers should look after the details and help raise the funding and agree the price.”

‘Wall of money out there’

At least part of this activity is driven by the availability of funding. “Ireland is in as good a position as it was back at the peak of the Celtic tiger,” he adds.

“There is a wall of money out there. You have got funds like MML, Cardinal Carlyle, Bluebay and so on ready to back MBOs. The banks are also very keen on MBOs. The banks want to lend money and back trading businesses.”

Keenan also has some advice for would-be MBO teams. “The guys that do well are those that spot the opportunity,” he says. “Most don’t see it; it can be a family business where the owner is getting older and wants to retire; it can be a multinational where the local business is non-core.

“The second bit is to get the team to focus. There has to be a clear leader or a small group with a clear leader. The MBO team should be those that will drive the business for the next five years and not necessarily those who have done it for the past five, 10 or 25. The 40-year-old on their way up may get preference over the 60-year old who has been there for a long time.”

He points out that the sale price to an MBO team will often be 10 to 20 per cent below that available from a trade sale. “But you would be giving that to the management in a loyalty bonus in a trade sale anyway,” he adds.

Graham Reid believes pricing is not always top of mind for vendors. “It is certainly in the two or three but there are other considerations such as the fact that the existing management are in a good position to ensure the business continues.”

Setting the price can be left to the market in these circumstances. “Very often a management team is allowed in at a later stage in a sale process,” Reid explains. “The price will have been set by the market. Vendor due diligence at the start can avoid problems and conflicts with management teams during the process.”

PwC corporate finance partner David Tynan points out there is more than one way for a management team to become involved in the process.

“I have been involved in selling a business over the past few months,” he says. “The management team initially had a private equity partner on board but the sale process took longer than anticipated and the slowdown in the US economy caused the private equity firm to drive the price down to such an extent that the management team was able to afford it without them. We ran a competitive process and it was only when one of the parties started haircutting the price that the management team decided to go it alone. The MBO was very much a fall-back position but that’s how it worked out.”

And there are cases where the MBO deal can be done in alliance with private equity firms, according to Conor McKeon of Cantor Fitzgerald. “Bank debt has traditionally played a major role in funding MBOs,” he says. “But there are alternative forms of funding such as vendor finance and private equity which management teams can look to. Partnering with a private equity firm is a good option.”

Katharine Byrne also emphasises the importance of a flexible approach to funding. “Funding an MBO will come from a variety of debt and equity options,” she says. “Most MBO teams require some form of equity to supplement their own contribution. Depending upon the scale of the deal, the equity partner may end up holding a significant ownership stake or may be provided in form of preference shares or loan-notes at a fixed rate.

“The key to funding an MBO is to ensure the returns for each funder can be achieved while still providing sufficient incentive and return for the MBO team.”

The endgame is also critically important. “You need to buy well, trade well, and sell well,” Byrne adds. “There is no point in an MBO if you don’t see an exit. This has to be front of mind.”

And Paul Keenan says teams should be sure they can reach a successful conclusion before ever starting out. “MBOs shouldn’t even start out if there is a prospect that they can’t finish. That can open a Pandora’s Box of future problems for the company. If the team believes the MBO can happen they should talk to an adviser about the structure of the deal and see if it can be made to work.”