Buying with diligence

Adam Bernstein
Wednesday, October 26, 2022

In the second part of our focus on MBOs, we look at the buyer’s perspective and assess the advantages and pitfalls of buying the business you are working in.

Buying a company via a management buyout – an MBO – seems like a match made in heaven. A seller wants, for whatever reason, to move on while a buyer ensconced in the business seeks to buy something that they are familiar with.

But of course, as with anything in business, an MBO is much more than that and requires consideration of myriad issues.

In the last issue we examined MBOs from the seller’s perspective. Now we look at what buyers need to know.

Structure matters

For Debbie Jackson, a partner in the corporate group of Walker Morris, an MBO – the acquisition by a company’s management team of the business they manage – is often about dealing with practicalities.

That aside, she says that MBOs offer all forms of owner, including owner-managed businesses and large corporates, “a form of exit that leaves the business in the hands of those who, by reason of already managing the business, are often best equipped to help the company grow and succeed financially”. For the management team she says “an MBO brings control and reward along with more responsibility and risk associated with becoming owners compared to being employees”.

Naturally every MBO will be different and so the structure of the acquisition will depend upon the business being acquired. As Jackson outlines, if it comprises a self-contained business within one company then the acquisition of the company’s shares would be the most likely route. However, she says that “if the business is part of a larger business it may be necessary to acquire just the assets and liabilities of that particular business; a share acquisition has the certainty of acquiring all the business and assets, but the company’s separate legal personality means that the buyer has no control over what is obtained as all the assets and liabilities – warts and all – will be acquired”.

A better solution, reckons Jackson, is “an asset purchase where the buyer acquires select assets and assumes responsibility for only certain liabilities, leaving behind any unwanted liabilities”. She adds that while an asset purchase seems ‘cleaner’ for buyers, “they need to ensure they get all the business and assets they need to continue the business going forward”.

However, asset purchases can be more complex if the nature of the business means certain licences or permits must be transferred, or new ones obtained, for the business to continue. But on the flipside, Jackson sees those running the acquisition having first-hand knowledge of the business so are best placed to understand what assets the business needs and the skeletons that may be hiding in cupboards.

Due diligence is essential

Due diligence is a term often used since it is an essential part of the MBO process – in spite of what a management team may know of their business.

And Jackson details its importance. “MBOs,” she says, “need to be funded, often through a combination of management’s own resources, third-party debt and equity funding from private equity investors and debt providers. External funders need to gain a complete picture of the business and its critical success factors, strengths and weaknesses – this makes due diligence essential to underpin the price being paid and to ensure that the right contractual protection is obtained.”

To pass due diligence, solid preparation is key in Jackson’s opinion. It should seek to address any issues in advance to avoid last-minute surprises and ultimately minimise the risk of value reduction that will affect the seller’s pay-out and what funder’s will back.

But this leads to a particular challenge that Jackson identifies – the thorny issue of due diligence and the extent to which a business is prepared to allow access to the books. She notes that many disposal processes include ‘vendor-initiated due diligence’ where independent accountants prepare a report that will be relied on by the buyer. However, she warns that “this process also gives the seller and their advisers the chance to flag up potential issues and when businesses are not properly prepared for sale, deals can go awry very quickly”.

As to how due diligence should be conducted, Jackson says that it requires extensive investigations into all aspects of the business with the management team verifying its financial standing, the tax, legal, commercial, and insurance position as well as other specific areas of the business depending on the nature of the firm. For Jackson this presents a number of challenges for the management team that includes “being able to focus on keeping the business moving forward – it is very important they do not get distracted and forget about the day to day running of the business and allow it to decline”.

In terms of timescales, these will be driven “by the parties involved and their willingness to agree on a deal,” according to Paul Philbrick, managing director of Close Brothers Asset Finance’s Print division.

“It’s important to assess and identify the steps required to complete and attributing realistic timescales to each. Then both parties can agree to a target completion date,” he adds.

Avoiding conflicts of interest

With every MBO comes the need to manage the unavoidable conflict of being both a buyer and seller and the challenges that come with this.

And valuing the business is often where this comes to a head. Jackson comments that “a buyer is going to want to make some money and perhaps, particularly where private equity is backing an MBO, ultimately sell the business on”. This is why she says that there needs to be a perception – and reality – that “the buyer is buying a business at a price that is right for the seller but leaving enough in it for the buyer to turn a profit and sell it on”.

Good advisers and backers

It’s very easy for a management team, caught up with the process, to fail to have their own advisers in place; they can, as a result, not receive the advice they need to ensure their stake in the buyer and their future package and incentives are right for them.

It’s for this reason that Jackson, naturally, says that “engaging a specialist adviser early in the process will enable a buying management team to take advantage of any tax planning opportunities and can add value and avoid potential pitfalls”. She continues: “A good adviser should be able to guide a management team through the process whilst giving insight into the current market trends.”

But while the buying team needs people with experience and expertise in MBOs to identify potential roadblocks before they are hit, Jackson also says that “they need people they can work with, someone who they can truly relate to and get along with... someone who can keep team spirits up to help alleviate the stress of the deal”.

Lastly, there is the requirement to choose the right funder, particularly where the MBO is private equity backed and the funder wants to be involved in the ongoing business.

On this Jackson says that the management team will need to be satisfied with the track record of the funder and how successful they’ve been in investing in other businesses in the sector. She says that the investment strategy of the funder for the business must be assessed and suggests asking a number of questions: “Are they able to support the value creation strategy of the business through, say, acquisition targets or organic growth and expansion? Is the funder’s investment team the ‘right fit’ – have they got the right capabilities and experience? In other words, are they people the management team can work with?”

On the other side of the coin the funder will want to see a comprehensive business plan that offers “a clear vision of the future with projections that demonstrate the business will be sustainable going forward,” says Philbrick.

He says: “There needs to be clear direction on how they wish to take the business forward, including forecasts that show viability; variables have been considered and there is an element of flex to the plan.

“Also, very importantly, a clear narrative that paints the picture behind the numbers and tells a story.”

The MBO tem don’t necessarily need to have every detail nailed down, however. Philbrick adds: “Often, it’s not just about the numbers, but also people’s goals for the future.”

In summary

An MBO involving a change of ownership needs to be managed externally as well as internally as it can bring uncertainty to employees, customers, suppliers and other stakeholders which needs to be sensitively managed.

That said, Jackson believes that successful MBOs not only complete due diligence and other associated processes, but they also in the closing stages of a deal carefully think about the communication strategy and its implementation. “Remember,” she says, “there are legal obligations regarding communications, especially with employees, and particularly where there is a union involved, and these must be followed.” 


Eight Days a Week Print Solutions

Lance Hill, managing director, says that Eight Days a Week Print Solutions (EDWPS) was the second time he had been involved in an acquisition, the first one being a VIMBO (vendor-initiated management buyout) of the 4DM Group in 2007 “which was considerably more complex, and took a lot longer to get over the line”.

He says that in terms of planning, “the start point was the funding and having a good understanding of the requirements of the vendor, which was very simple in my case as I had – and still do – a great relationship with the now former owner, David Beardsley.”

In terms of timing, Hill said that “we started getting into serious dialogue about it in July 2020 and the deal completed on 30 April 2021. I had no real expectation in terms of timeline, neither David or I were in a hurry, so it was more about getting the deal right, and ensuring it was sustainable, whilst keeping a lot of plates spinning.”

The MBO was spurred on by the fact the business was up for sale when Hill joined EDWPS as MD in 2019, as Beardsley handed over control to him from his first day. He says that “once I had got my feet under the table, got a good feel for what could be achieved I quickly recognised the opportunity, and it was clear David’s preference was an MBO rather than an external purchaser coming in.”

Due diligence

Hill says due diligence was ongoing on a day-to-day basis. Even so, he says that “it is important to get a good accountant who is experienced in acquisitions to go through the numbers and ask lots of questions. This includes the valuation of the business, what the next five to 10 years look like in terms of sales and financial forecasts, investments required, and the risks, etc”.

And part of this necessitated good advisors for, as Hill says, “without good accountancy and legal advice, you are dead in the water”. He adds that having the prior experience of the 4DM MBO helped, as did talking to close and trusted industry allies who had done the same.

He firmly recommends that accountants and lawyers are integrated into the process, “even when the deal is a friendly one, you need to have that expert advice and counsel to guide you through the unknown areas”. He’s a pragmatist and sees the need for the seller and the buyer to both be happy with the agreements, even if they’re never referred to again. 

On funding and performance

Initially Hill considered an invoice finance facility, but after going through many hoops to provide all of the information he says it became clear that the deal could be done without it as “the business was flying at the time, and therefore generating a good level of cash”. He pours scorn on his bank as “it pulled out at the last minute and would not give a reason which really hacked me off. But I had the last laugh as we did the deal without them.”

As for business performance since the deal was sealed, Hill comments that “in fairness 2021 was already going to be a record year before we completed so that was great for confidence going forward”. He’s diversified further and set up the Eight Plus division and taken on more people, “which will make 2022 another record-breaking year in terms of top line sales”. Notably Hill says that everything he’s put in place would have still happened had Beardsley remained as owner “as he trusted my judgement. He was the first one I spoke to when we were looking to set up Eight Plus.”

And being the new owner Hill has found changes - investments in both people and kit – to have been simple: “I take informed decisions and then the corresponding risk which I am not afraid to do as I am confident in what this team can achieve. We have the benefit of having a very solid bank balance, which helps makes some of those decisions a little easier.”

In terms of the future, Hill’s philosophy and strategy haven’t changed. He says it is to continue to grow the business organically – with maybe the odd acquisition “if it’s the right fit” – whilst “never losing sight of our core principles which is to deliver class leading customer service, quality and value for money, whilst always adding value”.

And it’s telling that Hill found that staff were not massively surprised by the MBO as they could see it was likely with Beardsley stepping back. He says that “it was very much business as usual – so important for the staff. They had continuity and the knowledge that we were in good shape and going in the right direction”.

Parting advice

In closing, Hill recommends that “for anyone considering an MBO, the first port of call should be talking to someone who has the experience of doing it before, or acquisitions and investments - even better if they are in the sector”. He says that buyers need to understand what’s required and have the right support from an accountancy and legal perspective – “you need people around you who you trust and have a good rapport with, this should not be underestimated”.

He adds: “You learn a lot. This one was very different to 4DM as that was a much bigger company; our finance director who was part of that MBO team did the vast majority of the heavy lifting and number crunching. I didn’t have him in this deal, so I felt the need to replicate that with someone else, an accountant I was introduced to with the right expertise and back catalogue of deals. Through them I was introduced to a good lawyer, and as they had worked together before the relationships were already in place.” 

Would Hill do it again? Yes: “In a heartbeat – it was the best, and simplest decision I’ve ever made and now I’ve got the experience and confidence to look at other opportunities too.”

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