Put simply, there are many people who were keen to sell their business at the start of 2020 but couldn’t because of the dire circumstances. Most of them still want to sell. Equally, many people will have nursed their business through this tough patch and will decide that now is the time to take a well-earned rest. There are even entrepreneurs who have seen business boom over the past year – and are keen to cash in.
For some businesses, the M&A market is picking up. Corporates with cash – borrowing is still incredibly cheap for big businesses – might well show an interest in snapping up smaller and medium-sized companies to fill out their geographic spread, buy customers or bring in some useful intellectual property.
But some business owners – especially founder-managers at what we call mid-market business, with a turnover between £2m and £20m – balk at the thought of a corporate takeover. Often, they’ve grown the company from scratch and personally brought in all the people now running the business. They feel the brand is their legacy and these relationships too important to surrender to a large corporate where senior people could become cogs in a machine.
That’s where the management buy-out (MBO – or buy-in, MBI) comes in.
Keep it in the family
In an MBO, the management team takes on ownership of the business by buying out the founder or majority owner, letting them cash in and retire from the scene. Sometimes a founder will hold onto a stake; sometimes they will invite in an outsider to take on the business (the MBI) respecting its structure and personnel.
In many cases, the management team can’t raise enough money to buy out all the equity held by the founder. In larger companies, the difference is often made up by a private equity house (which will take the bulk of the equity, leaving management with less money to find for their slice) with a big tranche of debt.
But many mid-market businesses won’t catch the eye of a private equity firm. Smaller companies – with an enterprise value under £5m, say – in particular will end up fishing for angel investors or buy-ins, rather than private equity firms. (The PE firms, in any case, are mostly interested in high growth strategies – which isn’t always the best play with mid-market companies.)
Finding the funding
That’s often where we can help. As specialists in valuing and lending against a whole variety of assets – from the order book and stock, to plant and machinery – we can take a look at the business and crystallise value for the management team. Here’s how it works.
Anne is the founder and CEO of a local equipment hire business. It’s been really successful – even during lockdown – but it’s also been hard work and she wants to retire. She would love the management team she’s assembled to stay on and keep the business going.
But there’s a problem. Anne’s accountant has valued the business at £4m. The four executives together can only get together £250,000. Anne is happy to defer payment for a fairly big chunk of her equity – £2m now, and £2m over the next three years. And that leaves a pretty hefty shortfall.
There is one small private equity house looking at the business, but Anne isn’t sure about their intentions (they’ll want to flip the business within five years) and the management team have been told to “lawyer up” on their own contracts if they decide to negotiate for their slice of the equity. That alone is going to cost them a fortune, and dent the amount of money they have left to actually buy into the equity.
The management team are pretty confident, though, and seeing as how the business is debt free, there is an alternative. For a start, it’s equipment-intensive. The ‘yellow metal’ machinery that the company hires out is in strong demand, and that makes them quite valuable as assets.
So we can either buy them and lease them back to the business, creating an instant cash influx. Or we can lend against them as assets. This way, the new owners are effectively taking on the liability of the leases or loans against the assets; and they’re paying out Anne from the proceeds.
Then the business itself is buoyant. The strong order book and healthy sales ledger are another big opportunity. Invoice discounting is a brilliant way of freeing up working capital – but it’s also an ideal way to create a one-off bump that can pay out to Anne, with the new owners either slowly unwinding their invoice discounting position; or maintaining it as an efficient way to optimise working capital.
Anne is able to walk away with her £2m. The management team have invested their £250,000 in her shares, and as new owners have raised the rest from the business thanks to asset-based lending. They’ve also put in place a temporary salary sacrifice to ensure cashflows remain stable. But the business – with all its potential – is now theirs. Within five years, Anne will be paid out, some of the ABL structures will have been unwound and the enterprise value when they come to sell will be even higher.
What happens next?
We’re just starting to see more of these deals build up now. The easing of lockdowns means many entrepreneurs are getting ready to sell. We’re seeing quite a few overseas businesses looking to divest themselves of smaller UK subsidiaries – either for strategic reasons or due to complications such as Brexit. And we’re seeing more battle-hardened management teams who have weathered the storms for the past year or two seeking to buy their businesses while conditions keep equity value a little lower.
In some cases, deals that are being financed through external equity and term loans are also under additional pressure. For example, deferred taxation during the pandemic or Covid-19 loans will start to catch up with many businesses – and they can help offset that drag of working capital through a deal process by using asset-based finance. In other words: even if Anne’s management team opted for private equity investment, we would probably have been useful to have in the room.
The other issue we often come across is MBO teams looking to make a break from the past – either working with new banks or looking at more up-to-date financing structures, with asset-based finance and leasing offering excellent alternatives.
And for many MBO teams, the deal is a chance to go for a reboot, looking at how the business makes transitions in crucial areas such as new forms of mobility (electric vehicles, for example), energy (switching to more power-efficient equipment or renewables) and digitalisation (taking important steps to open tech-driven avenues for growth).
Ultimately, MBO teams want three things. The chance to take control. The financing to turn themselves into owners. And the flexibility to shape the business under their stewardship. Lots of external factors look ready to open the door to MBOs as we come out of Covid in 2021 and 2022. With our entrepreneurial instincts and commitment to be a financial wingman for our clients, helping them make space to grow, we can help ensure those three drivers are deliverable too.