MBOs, MBIs and BIMBOs

Key points to bear in mind

In preparing for a deal of this nature, the following areas are just some of those to think about carefully:

1. The Management team

Who will advise the Management team?

The choice of corporate finance adviser is key. An accountancy firm that is the company's auditor is not an appropriate choice. It is vital to get the right corporate finance adviser on board who brings transaction experience and deep knowledge of commercial realities and the funding markets.

How much will the team members be expected to personally invest?

As a rule of thumb in an MBO, management should be expected to invest anywhere from six months' to one year's gross salary to demonstrate commitment and have some 'skin in the game'.

For an MBI, the monies required can vary, although you should expect to invest at least a six figure sum. The concept is that if you are willing to invest so much money, you will convince other stakeholders to do the same. You will always be first in and last out - taking the most risk and attracting the highest rewards.

Are there or what if there are any gaps in the management team?

An incomplete team is not necessarily a deal stopper and we can help identify and plug gaps. However, a strong leader is absolutely essential and all stakeholders including funders will want to understand your team building plan. This person will also be expected to lead the process and negotiations. It is imperative that the other team members believe in that individual's ability to manage the process, allowing them to deliver on their day-jobs.

In an MBO, will management be expected to give warranties about the business?

Management is in a privileged position and would be expected to give straightforward assurances about factual matters. The extent of any warranties given and limits on group and individual's liability is a matter for discussion and negotiation at the legal stage of the transaction. Specialist insurance packages are available to cover for warranty claims but the premiums are expensive.

Liability under warranties can be inter-alia 'joint & several', 'several', 'capped', subject to de-minimums levels and time dependent. Legal advice is necessary to understand the significance and implications of each.

Will you be expected to give personal guarantees?

Debt and asset based lenders may seek more security than the available assets and insist on additional personal guarantees. This adds an extra element of risk to you and requires careful consideration. The extent to which these are given is subject to negotiation. The risk associated with a personal guarantee depends on whether it is collateralised or not and whether the potential financial exposure to you is capped.

Do you have a plan?

You must have a coherent and logical plan as to what you want to achieve from buying the target business. Your business plan is your primary marketing tool. The document should be pithy and should define strategy and to build the investment case for potential funders. Remember, funders may ask you to warrant the contents of your plan and the associated numbers as part of the legal process.

2. The Business

Is the business cash generative and able to support a high level of debt?

MBOs may be financed through a combination of debt and equity. One class of funder is looking for a capital repayment and an income stream whilst the other is looking for capital growth. Free cash flows after the deal must be sufficient to repay interest and capital to providers of debt and earnings and must be sufficient to satisfy banking covenants.

Are there assets that loans can be secured against?

From your perspective, debt is cheaper than equity and should be maximised where prudent to do so. Banks require security over assets in the event of default or liquidation, so consider the availability of fixed assets, debtors stock and other assets as security. However, high levels of fixed debt have to be serviced whatever happens to trading and profits, so getting the right balance between debt and equity is critical.

Is there a consistent track record of turnover and profit growth? Can it be further improved?

A company with no vision or growth potential is not an attractive proposition for equity funders. Past performance is one indicator, but not a guarantee , of future growth. Funders need to believe in your strategy and ability to deliver the plan.

Are there concentrations in supply, the customer base or the goods and services sold?

These have an adverse effect on the valuation - so create a deliverable plan to improve the position. This weakness needs to be reflected in the price expectation.

3. Longer Term Considerations

What is the exit strategy for the business and over what timescale is this likely?

Banks are concerned with liquidity and cash flow. Ensure your plan demonstrates interest and capital repayments can be made from cash flows over the term of the loan.

Equity investors want an appropriate return for the risk they are taking. They want you to have to have considered where and how an exit is likely to occur. The likely exit scenario is a trade sale - so consider who might buy you, why they might do so and when. Remember - investors will carry out due diligence on your exit predictions - so research them carefully.

How can you retain and incentivise the remainder of your team?

Both you and your funders will be keen to see key employees tied into the success of the company. The most common tool used to create this goal congruence is an option pool. The proportion of shares earmarked for this pool will be subject to negotiation. Tax efficient option schemes are very attractive to employees and can add significant wealth and motivation.

Potential deal stoppers

You are in a minefield when completing a deal - some risks can cause deals that lead to increased costs, whilst others can kill a deal. The following list gives an indication of where a deal can come unstuck:

• Trading performance dips during the MBO process - "eye off the ball"
• The business plan exaggerates or optimistically overstates trading and cash flows
• Loss of a key customer
• Other bidders - e.g. trade buyer
• Internal disagreement - i.e. within your team
• Poor tax planning - for investors and management
• Un-fundable original deal