MBO – a management buy-out is where the employee/s purchase the shares of the company they work for

MBI – a management buy-in is where an outside individual (rather than a business) buys the shares

BIMBO – you guessed it, it’s where there’s a team consisting of both employees & outside individuals

VIMBO – ‘vendor initiated MBO’ generally means that the owner/vendor is financially backing the acquisition of his company buy his employees by agreeing extended deferred payment terms

What’s so great about MBOs?

1. The employees already know lots of elements of the business – staff, customers, suppliers, products etc so the handover period should be smooth;
2. There will be little change in the business model (apart from ownership), which means the banks should be slightly happier to support it;
3. There is generally a less adversarial attitude to negotiations, with everyone wanting the deal to work at a fair price;
4. There should be lower deal costs (from professionals etc) as there’s little marketing required to find a buyer and the scope of due diligence is probably narrower than an external purchaser would require.

What’s tricky about MBOs?

1. The new management team may not have respect of other employees in their new position, may lack key skills in managing the business going forward & may want to implement rapid change to ‘make their mark’;
2. Funds may not be readily available by purchasers, so a lower value may be accepted and/or it is likely that deferred terms will have to be accepted by vendor;
3. The MBO team will require access to confidential information for their due diligence, and if deal aborts there may be concerns about risk of future breaches;
4. It can be difficult for an MBO team to negotiate with their employer at arms’ length whilst continuing to work for them, including possible conflicts of interest and if the deal aborts, the business may lose a key employee

Recognising that this is such an amazing but probably scary opportunity for management teams, The Corporate Finance Network devised an MBO Training Programme for potential MBO Teams which they believe ensures any future MBO progresses smoothly and successfully.  Further information can be found by emailing info@corporatefinance.org.uk

1. it has a good reputation, is profitable and growing;
2. there’s a strong hierarchy with few areas being reliant on the main business owner;
3. costs are well controlled, operations are well managed and systems are in place to ensure efficiency

Now what else can you do to make sure you get the highest value possible?  The key is to remove absolutely all the potential or perceived business or financial risks.  This is the stage where you ice the cake & put the cherry on the top! 

Things like:

• write a disaster recovery plan, including what happens if - you are snowed in & your staff can’t get in or out, and neither can your deliveries; your key employee goes on sudden and long-term sick; your major supplier or distributor or haulier goes bust; the obvious ones like a fire or flood occurs; the electricity goes off and you have a prolonged power cut;  all of these possibilities, however remote, need to be thought through, and you need to have a plan so that you know how you would continue trading, as quickly and as efficiently as possible.  Consider your IT systems, access to telephone numbers and telephone lines – your staff, your customers, your suppliers and your bank!
• use daily or weekly KPIs to monitor your business’s performance – not just relying on monthly management accounts
• have a good track record with PR, both locally and nationally, both offline and online, and also have a crisis plan for potential bad PR
• ensure your website’s SEO ranks you highly on google – if you search for your sector, what do you find?
• carry out an insurance risk assessment and act on any of the recommendations to reduce risk
• maintain a superb fixed asset register – not just cost & nbv but also monitor repairs for each asset, location/user, efficiency/downtime etc, insured value, secured lender, expected renewal date etc
• if you’re not already accredited with Investors in People, adopt great HR policies anyway.  Appraisals, training need assessements, recruitment policy, interview structuress, disciplinary procedure, family friendly working policy, disability policy, exit interview formats, induction systems etc
• Regularly carry out and record customer satisfaction surveys, and monitor what % of new work comes from existing customers
• have a succession plan & strategy for each of your key management and senior teams, not just the business owner.  Consider training requirements, if there’s any need to recruit or headhunt, and how you’ll incentivise with cash/shares and a structured system for promotion

Once you’ve dealt with all that lot, you should have them knocking the door down to make you an offer!

I often see a SWOT stuck in an appendix of a business plan and wonder why it’s there at all, a complete waste of paper & ink in many respects. Like Del-Boy & Rodney who turned up in fancy dress, it’s there and present at the event, but just wishes it wasn’t!

I think SWOTs are incredibly useful, and they should be intrinsically tied-in to the rest of the plan. The reader of a SWOT shouldn’t have any questions to ask if they’ve already read the plan. Their concerns should have been allayed (or at least measured) and they can quite obviously see the positive aspects of the company. Instead, with many business plans you read it, and then read the SWOT and think “and so…?”; or “well, what are you going to do about that?”; or “oh crikey, this business is in trouble!”

More practically, I use a SWOT as one of the first stages in preparing the plan in the first place. It’s central to and leads my discussion with SME business owners when trying to understand their business, and for us to frame the plan in the best possible light. And, recognising that few small businesses spend any real, structured time considering their strategy, it can speedily clarify for them what direction they should be taking. Then the strategy, and the words that develop in the narrative, will aim to maximise the positives, and minimise or protect from any negatives (of which there should be some, by the way – SWOTs which no ‘W’ or ‘T’s will be dismissed as uncredible immediately!)

So embrace them! Enjoy preparing them and use them to their fullest, whether your plan is for management purposes or for fundraising.

If you’d like a handy checklist of areas/questions to consider when preparing a SWOT, please email me on kirsty@corporatefinance.org.uk and I’ll happily send one over.

Let’s talk theory first.  There are 4 acceptable valuation models.

1. Price/Earnings Multiple method – you remember this one, it’s about calculating the maintainable recurring earnings (taking average EBITDA after adjusting for add backs, then taking off Corporation Tax) and applying a suitable multiple.  And this is the huge challenge – what multiple?  Most SMEs in this market can expect 2-5 times earnings; the BDO Private Company Price Index stands currently at just over 12, (but this is for mid-market transactions average size £13m) and let’s face it, we could argue for hours about what this figure should be.
2. Assets basis – ideal for property or asset-intensive businesses (such as farming) where the P&L is just a sideline to the main business of holding assets – obviously use current values, not just book values
3. Dividend basis – generally only relevant for listed businesses
4. Discounted cashflow – lovely for the excel enthusiasts!  Use projected cashflows (oh dear, the problems start here!), then discount to present value using appropriate cost of capital.  Useful where minimal trading results, or significant investment needed to turn it around. 

So which method should you use?

Well, the most SME-appropriate methods are a mixture of 1 & 2.  P/E plus major assets, such as L&B.

However, let’s add a dose of reality.  Whenever I’ve been acting for a purchaser, in each and every case, my client was willing to pay what they could afford to.  They looked at the unencumbered assets of the business, the facility they could obtain from a lender, and added whatever resources they had.  What’s this got to do with the theoretical valuations above?  Not a lot! Except it’s a line in the sand that the vendor would probably want to work to.  And when you’re bidding for a business in a competitive environment (with a vendor or an IP), you’ve got to bear in mind what the seller is going to want versus what most purchasers can afford to finance (there are very few cash-rich purchasers around for SMEs).

Now obviously each potential purchaser will have:

• a different level of resources available to him/her
• different requirements for taking that business forward (a competitor who wants to asset strip & shut it down will pay less than an MBO team who have the ‘once in a career’ opportunity to run their own company)
• a different view of risk, based on their own current situation and the other options they have

And therefore they will all offer a different price for that same business.

So how should you value a business? 

Don’t even try!

The more savvy entrepreneurs are making acquisitions.  Either buying businesses who are competitors, or diversifying a little (such as vertical integration) or a lot (in a completely different sector).  And how are these deals being funded?

Well on the whole they use the most common form on finance in the market at present – vendor finance.

Yes earnouts are definitely the order of the day.  Which is bad news for vendors, but good news for those savvy purchasers who want to pick up a deal with little or no risk. 

The expression ‘earnout’ needs to be carefully defined, as it can mean different things to different people.  A traditional earnout is one that has performance clauses attached to it.  For example, it may be that different amounts are paid depending upon the level of future turnover/grossprofit/netprofit/net assets etc.  or a key event occurring eg renewal of contracts, retention of customers, granting of some sort of IP protection etc.  If the vendor has an ongoing role in the business, and his/her efforts will be contributing to that future performance, then it’s quite acceptable to a certain extent to structure a deal in this way.

But if the vendor is leaving the business or merely has a minor/consultancy role, then he has little control how that business operates going forward, and is reliant purely on the ability of the purchaser to make a success of it.  This puts all the risk in the hands of the vendor, and is something that should be avoided in all costs – assuming the vendor has a choice of course. 

But earnout can also just mean deferred consideration that is paid in the future, irrespective of the results of the business.  This can be a way for a buyer to manage cashflow, and is less risky for the vendor.  The amount is set at the time of completion, and the vendor just needs to make a risk assessment of the financial capability of the purchaser and the merged operation to make those payments.  Insurance policies are available, but premiums start at quite hefty sums – £50k upwards in my experience.  So it won’t be viable (or even available) for the smallest deals.  The vendor, as a large creditor, is more than entitled to ask for other security until that consideration is fully paid.  And chattel charges over fixed assets, or 2nd charges on directors’ own homes, isn’t uncommon. 

So when negotiating your client’s sale, discuss the likelihood of earnouts with them early in the disposal & business marketing process.  Be aware that refusing to provide any ‘vendor finance’ at all will severely limit their choices of purchaser.  But clearly the risk shouldn’t be totally weighed in the purchaser’s favour either.  Assess your other options, and use negotiation tactics accordingly.  The weaker companies will have to be willing to wait for their cash.   And how do you make sure your client isn’t one of those weaker companies – exit planning, exit planning, exit planning!

In the past I may have thought that it was because I personally hadn’t mastered the technique for closing a ‘sale’, and I just frustratingly put it down to experience.  I knew that I had a great success rate when I was given the time, fees and a certain amount of freedom to turn a business into one that was saleable.  So where was I going wrong?

And don’t be mistaken, I’ve not stood still.  Over the years I have adapted the marketing message and refined my approach for doing the work.  There is so little available in the market for work programmes in this area that I developed my own, made it incredibly structured and attempted to ensure it was much easier for clients to understand exactly what needed doing in their own company.  And this certainly did make some slight difference to the more astute business owner.  But “One swallow does not a summer make” – quite correct, Aristotle.

Is it just because there will be fees to pay?  Of course, asking for more fees is always going to part of the issue.  But when I can demonstrate case studies that show what huge value can be obtained (as I could), only the most negative entrepreneur could disagree.

And I appreciate that a business owner has to prioritise his time & energy.  Even my short & snappy 90 minute workshop to swiftly identify the salient issues, was too much time to ask of some clients.

Is it procrastination?  “Yes, but not yet” is the typical response of most SME business owners who don’t really want to face the fact that one day they may have to leave their business – by choice or not!

I liken it very much to the business owner being asked to pay insurance for something that isn’t mandatory.  There’s always something else more critical to spend their money on, and other more urgent matters that need to be dealt with today/this week/this month/this year.

So another year passes by without anything structured being achieved.

And what happens when that day comes?  Either the sad day of finding out that the business owner is ill, or the joyful day of getting an offer out of the blue (see previous post!) that turns into a depressive time because the buyer’s not going to be pay what he thought it would be worth.  Or perhaps the wife threatens divorce unless he retires before he’s 80 (or husband I suppose!), or the business starts to fail because this MD runs out of energy and new ideas to take the business to a new level.  Then it’s too late, that’s what.

But, never fear…being a persistent so-and-so, I’ve not given up!  I’ve a new approach to Exit Planning and I’m very excited about it.  Maybe this will be the extra element that makes business owners sit up and take notice.  Your business should always be ready to be sold, even if you’ve only just started out.  So what is this piece of magic?  I’m not telling….yet!

1. Not surprisingly, it can throw a business owner completely off-track and take his/her focus off the business for many weeks or months.  Whether the deal goes ahead or not, potentially you can have a rocky road ahead as the ups & downs of a sale are thrown at you, probably before you are psychologically prepared to deal with it.  If the deal goes nowhere, you have to pick yourself up, re-motivate yourself and get on with running your business, forgetting any immediate dreams of sailing off into the sunset.
2. You may be tempted to grab the offer & run.  But if the business isn’t ready to be sold, it won’t achieve its true potential value.  But you may still be tempted to sell the business to this willing buyer – potentially costing yourself thousands & thousands of pounds.
3. I can virtually guarantee that the initial approach & values discussed will not be the final offer that is made.  Once a due diligence investigation has been conducted by the purchasers accountants, then their lawyers get their hands on the deal, it is likely to end up looking nothing like the original structure.  So make sure you are prepared for that too.

But of course, you shouldn’t look a gift horse in the mouth, and in most cases it is right to pursue this approach.  But it’s important to do so in a very measured way.  Ideally like this:

• Get your accountants involved.  Don’t get too personally involved in the early stage – you are not best placed to objectively negotiate for your own sale, and anyhow, you still have a business to run!
• Your accountant should ensure that the potential purchaser signs a confidentiality letter (but don’t grant them exclusivity) on your behalf, before holding an exploratory meeting at your accountants’ offices or somewhere neutral.  Some basic information has to be provided to give them a chance to check their understanding about what they are buying.  At the end of that meeting, if they are still interested, you need to put the brakes on!
• Very quickly, you need to get prepared and organised in 3 main areas:

1. psychologically – learn about the process you are about to take & get ready for a roller-coaster ride;
2. personally – incl tax planning and understanding what you are going to do when you leave the business, get some plans for your future; and
3. professionally – tidy up the business’s systems and manuals, get the ‘financials’ up to date & any outstanding contracts/litigation/tax issues should be dealt with quickly

• The best way to proceed is to try and get some competitive offers.  There’s no way any business owner can know if the deal is a good one until he knows what the rest of the market may offer him.  And those buyers making direct approaches often rely on being the only player, a strong negotiating position for them & a weak one for you.  So your accountants should (speedily) go out to the market of other potential purchasers with a teaser flyer and see what response you get.  They should be handling meetings and negotiations in parallel with the original potential purchaser, letting them know they have competition.  When you’re ready, invite your best party/ies to undertake due diligence and see where it goes from there.

If it doesn’t progress (well over 50% won’t), when all the dust has settled, you’re usually ready to think about some structured exit planning.  You can see that in the future you could sell your business for a sizeable figure.  But you can probably also tell that you were woefully unprepared. 

So take this opportunity to agree upon a ‘grooming’ process with your accountants for a few years.  Concentrate on the 3 areas I’ve listed above – psychological, personal and professional development.  And when the time comes around again to attempt to sell the business, you’ll have a much better chance of a successful outcome.

More on Exit Planning in the coming weeks…

Most fundraising assignments (yes, even in this day & age), business sales and deals in general, have many possible outcomes, so you and your advisor have to come up with as many different possible scenarios and solutions as you can.  So how do you do that?

Brainstorming is by far the most successful way that I’ve found, of getting your creative juices flowing.  And this is where creative thinking (as oppposed to creative accounting!) is most certainly called for.

How do you brainstorm?  Well as far as I’m concerned, it doesn’t have to be too structured, scientific or ‘arty farty’ management consultant mumbo jumbo.  For me, it’s simply a case of finding some people with decent brains and plenty of experience in SME corporate finance, sitting round a table (ideally, although on a teleconference or webconference will work too), and starting a conversation.  Someone needs to write down all the ideas that are mentioned (even the daft ones, you can review them for reasonableness later).   Keep talking, keep thinking & your ideas should spin off each other quite easily.

Let me give you an example…a contact of mine was trying to fund a start-up business in the leisure industry, and was finding it difficult to fund it through the typical routes such as VCs.  Now, this is a business I’m keen to see established (my kids will love it!!), so I wanted to help out where I could.  So over the phone, we just started chatting and the ideas started flowing.  After 10 minutes, we’d thought of another 4 or 5 possible funding sources, some very dubious and highly unlikely, but possible.  This included some large corporates who have corporate venturing funds to make investments in smaller companies, some companies/sectors who may be interested in doing a JV to obtain some strategic synergies, and an alternative structure altogether, that a VC may be willing to look at again.  It’s hard for any individual advisor, when they’ve been looking at a deal for some time, to ‘see the woods for the trees’, and now at least that gives him some more options.

So all you need to do is to make sure you and your advisor have some other people who want to help you & have decent brains!  Many accountants don’t have much support around them, so the more savvy ones make sure they find a peer group.  Has your accountant got access to an effective and proven peer group?  If not, change your accountant!  www.corporatefinance.org.uk if you need any ideas, and enjoy skinning that cat!

The company acts a broker between mobile phone providers and land owners.  They source appropriate sites for new mobile phone masts, and effectively takes a commission or a finder’s fee every month for either 10 or 20 years.  Now, if that was simply carried out by our target invoicing the mobile phone company and also invoicing land owner for their commission each month, that would be fine.  And as it’s a long term agreement, it would be a nice healthy income stream, and invoice finance companies would be happy to finance it.

However….they don’t operate their sales invoices in such a way.  Instead, the broker enters into a property lease with the land owner and then enters into a 2nd lease between the broker and the mobile phone company – obviously at an uplift which provides for the profit or commission.  Needless to say, invoice discounting companies are not interested at all!

So, even though they are trade debtors, because they are rental debtors and not true sales invoices, the business model won’t suit invoice discounting.  So the moral of the story is, if you are setting up a new company, think about what paperwork and contracts you use and consider, not only what protection you need from a legal perspective, but also how this paperwork might be needed in the future, as security for a potential finance provider.

Yes there are other ways to finance this business model, but they certainly aren’t as simple or cost effective as a simple invoice discounting facility would be.