ARTICLE ON MANAGEMENT BUYOUTS - BUSINESS DAY - MARCH 2007

Key steps to MBO ownership and value creation

In our previous article on private company MBOs, we demonstrated how values and internal rates of return were quantified. Our contributor, Kevin Homann, an MBO specialist at Spirit Capital, now describes key steps in a typical MBO process …

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Kevin Homann

MBO processes may seem complex to private company executives who are unfamiliar with financial engineering. This is usually because successful, goal-directed managers concentrate so single-mindedly on their business and the dynamics of their own sector.

Though technical issues may sometimes demand close scrutiny by a specialist, the basic process in a typical MBO is quite simple.

There are six key steps …

1. Speak to the owner. A manager contemplating a buy-out – usually the managing director or chief executive – should approach the owner to obtain an indication in principle that the owner is willing to sell the business to management. An executive may spot signs suggesting that the owner is thinking of a sale. The chief executive may, or may not, wish to involve senior colleagues in a broader consortium. Alternatively, the owner may take the initiative, recognising that a sale to his chief executive or senior team will ensure management continuity and lock in value.
2. Consult a corporate finance specialist. The manager will need expert advice from a professional with experience of leveraged buyouts and the private equity sector. These contacts are sometimes the result of referral and personal recommendations. Ask trusted industry colleagues about consultants known for technical expertise, high ethical standards and familiarity with private business dynamics. A track record of successful transactions in the private company sector is often important to help ensure a good understanding of the special challenges faced by mid-size companies and the psychographics of successful managers in this environment.
3. Develop an info-pack. Include current management accounts, audited financial statements and forecast information, but don’t stop there. A broader overview of the company, its industry and people will be vital when developing the investment case for the prospective MBO.
4. Approach your bank. Inform your bankers that an MBO is being considered and obtain an indication how much finance it may be prepared to advance on a senior and mezzanine debt basis. The level of debt is a key element in the financial models that will have to be developed. The bank’s appetite for involvement is also a key negotiating plus-point when talking to private equity investors. The level of debt has a significant impact on the equity shareholdings of the management team and the private equity partner.
5. Seek out a private equity partner. Sometimes this may be a wealthy investor or consortium of high net worth individuals. More frequently these days, a relationship with a private equity fund will be sought. All private equity funds share the same appetite for quality deal-flow. But not all private equity funds are the same. Some are focused exclusively on large deals involving major listed groups, some take on a ‘mix’ of work and some concentrate on smaller transactions involving private companies. Some funds specialise in certain industries; others focus on start-ups rather than leveraged buy-outs. A competent MBO specialist will help the manager to develop a shortlist of prospective investors with the right type of profile.
6. Negotiate a favourable deal. Meet executives on the shortlist of prospective private equity investors in turn. Make a detailed presentation. Working in tandem with your MBO specialist and advisor, obtain an indication whether or not the investor is interested in participation. Negotiate for the optimum terms, compare what each party has to offer and decide which fund will make the best partner.

During negotiations, the focus points for the manager typically include the ‘hurdle rate’ and internal rate of return expected by the private equity investor, the respective levels of equity shareholding and the ‘step-in’ and pre-emptive rights agreed to between the investor and the manager.

These issues and other value-adding pointers from your MBO specialist are the subject of the fourth and final article in our series on private company MBOs.

Homann is director of corporate and structured finance service provider Spirit Capital. This is the third in a series of articles on management buyouts.

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