The MBO Process

Here we outline the basic steps in the management buy out process to give you a flavour of the issues that you might
face in purchasing your own business.

The first question you might ask is if there is actually a deal to be done. This might be initiated by the vendor for
reasons of trading results, investment priorities or strategic fit.

But as previously mentioned the MBO stats indicate that MBOs and MBIs have played a significant role in the UK
Mergers & Acquisitions scene and accounted for the large proportion of capital invested by Venture Capitalists and
Debt providers.

Indeed the number of companies that have used this type of funding has consistently increased year on year.

Generally, the prerequisite for an MBO is a proposed change of ownership. This is usually driven by perhaps the
proposed retirement of the current owners, the desire to realise capital value or perhaps a corporate owner disposing
of non-core assets.

Otherwise management must prepare the ground and make the case for divestment first and then for an MBO. 

Most private equity practitioners will tell you that they are often surprised or would look at a transaction more
sceptically if management teams have not engaged experienced advisors to represent their intentions and to progress
and project manage the transaction. 

The appointed financial advisors should have enough MBO experience to initially appraise the probability of success
and act as an interface between management and the vendor in initial negotiations as well as contacting the various
funding sources.

So after establishing the vendors objectives and likely price range, you should be aware of the potential competition
from trade buyers for your business and try and gain exclusivity with the vendor and decide on who could underwrite
the costs of the MBO.

Most Corporate Finance Lead Advisors will work on a largely contingent basis whereby they only get paid should the
deal be successfully completed.

Should a contingent arrangement be agreed, it is likely that the fees may be higher than the time costs incurred,
purely to reflect an element of risk perceived in the deal not completing.

So on this basis, you can understand the importance of drawing up heads of terms with the vendors.

Up to that point the relationship between vendors and the management team has probably been one of employer
and employee and this is likely to be the first instance where the relationship begins to change and which can lead to
conflicts.

Managing that relationship with the vendor and instructing an advisor to act on management’s behalf is crucial, as
there have been examples where the vendor has felt unreasonably pressured into exiting his business at a perceived
undervalue and he has pulled the plug on the transaction just before deal completion and given the entire MBO team
notice.

Again an experienced advisor can act as an interface between the parties and deal with any difficult issues that arise.

The heads of terms with the vendors typically cover the company and assets to be acquired; pricing and timing for
the payment of consideration; warranties; any abort costs; the timetable and exclusivity; as well as any non compete
covenants and items specific to the transaction such as Pension Scheme Liabilities!

The advisors may also assist in preparing the detailed business plan which should go someway to proving the
commercial financial viability of the MBO and assess whether it is likely to be fundable.

They will assist in identifying the opportunities and risks and the management responses to them.

It should also include a section on the management team and quickly identify any gaps that need to be filled.

Detailed projections and “what if” scenarios would also be incorporated into the plan.
If after all that the management team has decided to proceed then they need to formulate a funding package.

Again the advisor will consider appropriate sources of funding and consider an exit plan for management and
investors and the appropriate tax issues.

It is here that your advisor will guide you on the level of cash you may need to inject into the MBO.

In approaching both debt and equity providers, your advisor should send the business plan to those prospective
investors that are likely to find the opportunity attractive and help prepare the MBO team in presenting their proposal
to these investors.

These banks and private equity providers will then carry out their own initial assessment and hopefully draft an offer
letter, the terms of which, whilst subject to due diligence, may need some further negotiation with the assistance of
your advisor – including the mix of debt and equity and the amount of management shareholding.

Once offer letters from the debt and equity providers have been received, the MBO team should be able to present
this to the vendors with a viable offer for the business with conditional financial support.

The purpose of Due Diligence is for investors to validate their conditional agreement and gain a better understanding
of the risks within the deal.

The amount of Due Diligence varies depending on the type and size of the transaction. But deals involving a slug of
Private Equity generally include DD on management through referencing and some formal assessment.

This is often supplemented by Commercial DD on market conditions of the target with advice from sector specialists
on growth rates, trends, opportunities and threats.

A key constituent of this type of DD is on Customers, with a view to ascertaining the reputation of the business, its
management and its position in the market and likely level of future business.

Operational and historic trading, cash generation and management forecasts and sensitivities, which are
probably covered off in the Business plan would nevertheless be investigated as part of the Financial DD as well as
legal matters such as IP rights and any outstanding litigation.

Other forms of due diligence may also be undertaken such as environmental surveys and technical assessment of
products and services.

In summary – Management’s role should be to prepare and deliver the forecasts and minimise the impact on the
business and whilst we’ve touched on the broad issues in what you can see is quite a thorough and at times intense
process it’s the role of the advisor to project manage the MBO and negotiate the best possible terms with both the
vendors and potential funders.