Making a planned exit
Monday, June 28, 2021
Every privately held business will one day change hands. Whether through retirement, family circumstance or death, ownership will move on.
Business owners looking for an exit have a number of possible options including the traditional routes to market, which often involve working with corporate finance advisers or approaching competitors or colleagues in the industry. But there may be no successor within the family, or the owners may not wish to hand their business, built up over years, over to the tender mercies of private equity.
One solution, in this situation, is to sell the business via a management buyout (MBO). And as Printweek has highlighted on a number of occasions, most recently with the May buyout at Nottinghamshire direct mail and digital printing business Eight Days a Week Print Solutions, MBOs are nothing to be frightened of.
Defining an MBO
Paul Taylor, a partner at Fox Williams, outlines that at its simplest, “a management buyout is the acquisition of a business, in whole or part, by its management team”. It usually involves the provision of debt and/or equity funding by a bank and/or private equity investor.
MBOs tend to involve a share acquisition where the management buys the entire issued share capital from the current shareholders.
“Sometimes,” as Taylor explains, “a new management team will be brought in – an MBI – or other times it can be a mixture of existing and new management, hence the uniquely named BIMBO.”
But owner exits don’t always happen on the fly. In fact, Samantha Chaney, a partner in the corporate team at law firm VWV, has seen owner managers plan an MBO many years in advance, bringing trusted staff into management as a form of succession planning. To her mind, the popularity of MBOs comes from owners who “see a management buyout as the conclusion of a long-term strategy to grow and push the business forward whilst keeping it within the hands of those that know it best.” And the example of Glossop Cartons illustrates this well (see case study boxout on page 31). It’s the reason why Chaney says that “owners … want to make sure the business is passed to the right people who have its best interest at heart, rather than a third party whose intentions are much more difficult to predict.”
She adds, however, that “MBOs are also an option for larger businesses led by a strong management team who have the skills, experience and the vision to take the company forward without the continued involvement of the current owners.”
Why an MBO?
It’s perfectly logical that any route to sale is often linked to the owner’s reason for selling and the structure of the business itself.
That said, Taylor reckons that there is no correct route to exit, and the format very much depends on a number of variables. He says: “The current state of the business; the appetite and resources of the management team; the attractiveness of the opportunity to debt and equity providers; and tax structuring advice to name but some of the elements.”
It’s also an option to use an MBO where potential trade buyers are limited in number or the seller is nervous about approaching competitors and disclosing sensitive information.
As to why an MBO is used, he says that for some it’s about stability as “key management team members will continue in office with minimal disruption for customers and suppliers”. Allied to this, he points out that the management team will be very familiar with the business “which will hopefully ease the due diligence and disclosure exercise”. Other reasons he cites are MBOs being “a well-trodden path and private equity firms often have deal teams and sets of documents on the block ready to go as well as a ready availability of MBO funding for the right opportunity”.
Also, importantly, he adds that there’s “less risk of confidential information being leaked to the market which is still a material concern if a trade sale is undertaken”.
No matter the driver, Taylor’s advice to sellers, especially those not involved in day-to-day management, is to “consult with a corporate finance firm for specialist advice on how to maximise the sale price... a trade sale may attract a premium, with a competitor keen to take control of a competing business”. But that of course requires a private and very personal moral debate.
MBO success isn’t automatic, but Chaney thinks it’s highest when an owner has trust and confidence in the management team. But as she says, “it is natural that during an MBO for sellers to have concerns that the buyer is taking steps to devalue the company. However, it is unlikely to be possible to impose measures and restrictions on management to avoid taking actions which might devalue the business because it could impede their work and is also not an ideal starting point for negotiations.”
Taylor is more colourful on the issue for he too has “witnessed, on a couple of occasions, management teams sabotaging a sale process, which involved competing third-party purchasers, to ensure that their MBO bid went through.” As he says, “this is the exit equivalent of a disgruntled divorcing spouse leaving the matrimonial home in a terrible mess to put off potential buyers”.
The only solution in Chaney’s mind is owners relying on the terms of any employment contracts or service agreements entered into by the management where there are requirements to act in the best interests of the business. To this she adds, and Taylor agrees, that “where individuals are also directors of the business, they will also be bound by their statutory duties to promote the success of the company for the benefit of the shareholders”. Breaches of these obligations could lead to dismissals or personal liabilities on management, and these are typically sufficient to ease concerns of the owner.
Many MBOs are initiated by the owners. But that’s not to mean that a management team who thinks an owner is losing interest in the business or is starting to look at alternative routes for sale cannot raise the matter.
But in addition to a seller or management team kicking the process off, Taylor says “that some of the larger corporate finance firms,” and he names two: Cavendish and Livingbridge, “will have their own research teams targeting business that may be ripe candidates for MBOs”.
For Chaney, how the matter is broached will depend entirely on the relationship between the owner and the management team. She suggests that where the owners are part of the management team a tentative discussion may be advisable in the first instance as raising the possibility of a sale in any form may be unsettling for the rest of the team. But she’s also found “that where an MBO has been part of a longer-term strategy of succession planning the owner may well have already extricated themselves from the business over time such that the conversation is welcomed by management.”
And, of course, if the company has private equity or venture capital involved, the discussion may arise naturally as it should be obvious that investors would have had an exit strategy from the outset.
Every sale requires negotiation and an MBO is no different. By definition, how it proceeds will be a function of the relationship between the owner and the management team, the sale price involved and how the acquisition is to be financed.
To ease the process Chaney recommends that owners consider appointing a corporate financial adviser to explore all possible sale options and to project manage the sale. She comments that “often at least three sets of legal advisers are involved – one each for the seller, the purchasing management team and the third-party funder, but there may be more if the interests of a particular side diverge”.
She warns that there is much at stake and if negotiations don’t go well, the seller risks the morale and commitment of the current management team. She adds: “This may restrict a sale via an alternative route in the near term as any resulting changes in personnel need time to bed down and prove successful.”
Another key risk comes from sellers pulling out against the wishes of the MBO team. It’s one that Taylor offers a concern over. He says that “a disgruntled management team could resign in order to progress an MBI opportunity, or to set up a NewCo to compete against the business, subject to any restrictive covenants in place.”
Where this gets interesting, says Taylor, is “if the management team were already holding a small percentage of shares in the business, they may be subject to restrictive covenants in a shareholders agreement which will usually be more enforceable than restrictive covenants in their service agreements.” He explains that that is because the starting point for the courts is that any restraint on a person’s ability to earn a leaving will be unlawful unless such restrictive covenants are reasonable. The same test is not applied if a shareholder has struck a commercial bargain to regulate a shareholding relationship.
He counsels that because restrictive covenant law can rapidly change, companies ought to “regularly review the restrictions imposed on their management team, if nothing else to understand how enforceable they are likely to be.”
In good time
An obvious question is how long will an MBO take to conclude? In response, Chaney says that “the extent of the management team’s prior involvement in the business along with the financing of the acquisition will more than likely dictate the timetable of the transaction”.
And in Taylor’s experience, “a typical time frame is two to three months from when heads are signed to actual closing”. He bases this on there being three distinct processes: the share purchase agreement and disclosure; a shareholder’s agreement and articles of association to be negotiated between the continuing management team members and the backers (if relevant); and the provision of lending and security documents if debt is being provided to part or fully fund the exit.
As to how an MBO will be financed, Chaney says that they are typically financed through one or a combination of the following: private funding by buyers using their own resources, debt finance from banks or other financial institutions or private equity funding.
By extension, where a third party is involved, she says that the transaction will inevitably take longer, as additional hurdles need to be jumped before completion. She also highlights that “third parties will normally appoint their own lawyers to advise them on the transaction, conduct due diligence, and prepare finance and security documents – and this all takes time. In addition, banks have structured internal processes to follow, and it is rarely possible to speed these up”. On top of that Chaney notes that if there is existing bank debt in the business or security against its assets, these will need to be addressed as part of the transaction because new lenders and investors will want priority over existing security.
But there’s another issue: non-management sellers having to give operational warranty protections to give succour to buyers. In such circumstances, Taylor says that “such sellers are very reliant on management – effectively the other side of the transaction – to assist and to make sure that a proper disclosure process is carried out”. But as he points out, a feature of an MBO process is the multitude of different ‘hats’ that management can be wearing at the same time: “One moment they can be helping the seller with the disclosure exercise and the next they can be sitting down with the MBO backer to pick holes in the very same disclosures.”
From Chaney’s standpoint, “it’s reasonable that where the management team are more actively involved in the business than the sellers, then the buyers may be less concerned about extensive warranties and indemnities. However, if the sellers are more actively involved and there are gaps in management’s knowledge then warranties and indemnities become more important”.
Any negotiation process, says Chaney, can become a little circular and, as with many private equity deals, the use of warranty and indemnity insurance can be used to plug the gaps. “In reality,” she says, “it may be that taking out a policy is in the best interests of all, as the risk of claims is low as a result of management’s existing knowledge, but should one arise then the financiers are protected.”
Success isn’t guaranteed
Chaney says that MBOs are at their most successful “where there is a strong committed management team in place with a mixture skills and experience who already run the business with very little input from the owner”. When executed well, she says that they can allow for a smooth transition with very few immediate changes, which is reassuring for employees, customers and suppliers alike.
But sellers have to be realistic about the price and the deal structure when going through an MBO. If there’s too much financial pressure placed on the management team at the outset the business can suffer and if part of the purchase price is dependent on future performance, then the seller will lose out in the long run.
Business transactions of this nature are rarely simple, and as Taylor says, “MBO’s can be particularly challenging... but my personal experience is that there’s no more material transactional risk than say a trade sale.”
Case study: Glossop Cartons
Jacky Sidebottom-Every is the former co-owner and joint managing director of Glossop Cartons, a company that has recently been through an MBO. And as she knows from first-hand experience that it is not an easy process.
She says: “We were getting to an age where we needed to think about an exit plan. Our children had no interest in the company and so a sale was always going to be our exit strategy.” She and her husband Brian looked at options and took advice from experienced industry individuals; they realised that it was time to start planning the exit a few years before they wanted to retire.
As to why the MBO was chosen as the exit vehicle, Sidebottom-Every said that the company had been a life-long project: “We lived it 24 hours a day, year in year out since we were 20, and we did not want it swallowed up by a multinational group as we felt that our clients still wanted that personal touch, the caring customer service, that made us so successful. We wanted our values and ethos to continue after the sale.”
The company is now in the hands of Wayne Fitzpatrick, who says Sidebottom-Every, made the first approach, asking for an informal conversation. He, at the time, was managing director of MM Packaging in Deeside. “In our conversation,” says Sidebottom-Every, “he said that he was considering looking for a new role. Although his career at MM had been brilliant and very enjoyable, he said that he felt that he wanted to experience employment at a smaller company where he would be able to have a more relaxed and less structured role, with the normal demands of a high achieving position, but without the formality that comes with large corporate organisations.” It was at this point that Fitzpatrick was told that the planned exit might be an opportunity for him going forward.
Fitzpatrick started working for Glossop in August 2018, initially for a year as sales director where he got to know the setup, the clients and how the company worked. After that, the family and Fitzpatrick had enough confidence to start exploring an MBO and how it would work. “This,” says Sidebottom-Every, “was a gradual process.” Fitzpatrick was given access to confidential information which, she says, gave more “confidence that he was the right candidate to buy our company”. On top of that, the company brought in experienced managers to the team to enable Fitzpatrick to take on the role of managing director after the purchase.
As for the terms of the sale, Sidebottom-Every told how early in the negotiations “we had discussed various valuations methods of our company shares; we decided on a valuation that was fair without being greedy. We were warned many years ago that the mistake owners make is over valuing the worth of their company, this causes many hold-ups and often results in companies not being sold”. She adds that “after we had made our decision we wanted to sell and not be tempted to U-turn”. While it’s entirely possible that a third party may have paid more, the future of the company was just as important to her.
As for the final exit, Sidebottom-Every and her husband have reduced their working hours to two days a week with a view to reducing this further over the next couple of months – “but we will be at the end of the phone if needed”.
In her time Sidebottom-Every says she has had three failed company purchases, two successful acquisitions and successfully sold her company. As a result, she thinks “it’s really important to be grounded, direct and honest. It’s no good beating around the bush – that just leads to misunderstanding and misinterpretation.”
She’s also witnessed legal advisers “ask millions of questions”, but as she says, “it’s easy to get a little exasperated and tempers can fray a little, but breathe deep and carry on – they are only doing their job.”