ARTICLE ON MANAGEMENT BUYOUTS - BUSINESS DAY - MARCH 2007

The negotiation secrets of MBO optimisation

In our final article on private company MBOs, Kevin Homann, our contributor and a Spirit Capital MBO specialist, provides added value with some inside tips on how to cut the best deal and develop the most rewarding relationships when entering into a leveraged buyout…

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Kevin Homann

Everything is negotiable. This is Rule No. 1 of MBO structuring, but some issues are tougher to resolve than others.

For example, price is notoriously difficult to re-negotiate once the owner’s expectations have been set too high.

To ensure inflated pricing expectations do not become a ‘deal-breaker’, it is best to be guarded at the outset. The management team should make no firm commitments until it has taken advice as to what can be done from a financing perspective.

When appointing your MBO adviser, remember not all financial engineering specialists are the same. Are you looking for a ‘broker’ or an experienced adviser with a hands-on approach who will advise, counsel and coach you throughout the process?

Thorough preparation is essential if you are to make a persuasive presentation of the investment case.

When preparing an info-pack (step three in our previous article), provide a detailed history of the business and its place in its industry. Consider the firm’s people as well as its products and services. Emphasize the growth prospects. Identify and systematically address the business risks.

Managers who ‘live’ the business don’t realise how much information they carry around in their heads. Write it down.

The management team is not only selling an investment case, they are also selling themselves and the value they bring to the business. This is a vital part of the evaluation process.

Management can’t negotiate properly unless they understand the principles of financial engineering and leverage. An experienced MBO adviser is essential.

An MBO generally represents a substantial financial opportunity for an individual. There is a danger that the key manager may want to maximise the personal opportunity, but think carefully before deciding to go it alone. Forming a consortium of key executives has a lot to be said for it. In this way, you ensure the continued support and involvement of senior colleagues.

Before making any presentation to potential private equity investors, it is advisable to tap your advisor for information on the state of the private equity market, industry preferences and the reputation of various players.

After your presentation and follow-up discussions, your objective is to obtain the most favourable terms. Key considerations include the management team’s share of equity, exit provisions and “step-in” rights.

Select a partner on the basis of the terms on offer. Do not make a decision on empathy felt for particular individuals on the private equity investor’s team. These executives are employees and may move on.

Even when the terms meet your expectations, remember Rule No. 1 – everything is negotiable. Nothing prevents you from ‘revisiting’ certain issues.

A good MBO advisor will unpack the detail of the financial models covering the private equity investor’s expected internal rate of return. But no one knows the business’ capacity for generating cash-flow like the management team. Returns are key for the investor and it will look to maximise them. You may have to stretch to meet the target, but it has to be do-able.

An investor manages risk by aligning its interests with those of the management team. This is generally achieved through positive wealth creating mechanisms e.g. co-investment and performance incentives.

Typically, the private equity investor’s role is that of performance monitor. Operational involvement is not usually necessary. However, the investor will have the right to ‘step in’ should performance falter. Clarify the circumstances that might trigger this intervention and what level of involvement it will entail.

Private equity investors always look to control the exit process. However, the management team should try to exercise a measure of influence if they can.

Pre-emptive rights during the exit phase may grant the private equity partner the right to “take management along”, i.e. secure a buyer not only for his share of the business but for the business in its entirety.

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

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