CLEAR GUIDE

Management Buy-Outs
 Contents

Introducing Clearwater Corporate Finance

1. The Basics 3. The MBO Process

a) What is a Management Buy-Out? (MBO) a) Piecing together the jigsaw
b) Why do management teams undertake MBO’s b) Why do we need to appoint a corporate finance adviser?
c) How to spot an MBO opportunity c) What will we need to include in a business plan?
d) MBO versus IBO d) Why will we need tax advice?
e) Will we be able to compete with a trade buyer?
4. Timescale and Costs
2. Key ingredients for a successful MBO
a) What is expected of the management team? 5. After the Buy-Out
b) How much money will we need to invest personally?
c) When should we approach the vendor? 6. Why use Clearwater?
d) Why are exit opportunities so important at the outset?
7. Clearwater’s expertise

2.
 Introducing Clearwater Corporate Finance

Clearwater Corporate Finance is a leading mid market Independent of any larger investment bank or professional
corporate finance advisory firm operating in the UK and services firm and with market leading research, origination
internationally. With over 400 completed transactions, we and deal execution skills, we go to market via the following
work alongside management teams, shareholders, private focused sector teams to deliver our clients the very best
equity investors, privately owned businesses and large service and advice.
businesses on all aspects of corporate finance transactions
including: • Industrials
We are also a member of IMAP, www.imap.com, the global
• Food
mergers and acquisitions organisation which is located in
• MBOs and MBIs • Healthcare
over 30 countries, and provides us with a unique position
• Company Sales • Technology
as a leading cross border M&A advisor to mid-market
• Corporate Acquisitions • Consumer
businesses.
• Development Capital • Support Services
• Debt Advisory • Financial Services
• Public Company Advisory • Chemicals
• Recapitalisation
• Equity Release (‘cash out’)
• Cross Border Transactions
• Exit Strategy

3.
 1. The Basics

What is a Management Buy-Out? The diagram shows 3 layers of funding namely from:

A management buy-out, more colloquially called an MBO, is the BANK

purchase of a business from its owner by its existing management
team usually with the help of financial backers.
The bulk of the finance required to purchase the business will
normally be provided by financial institutions, primarily from banks
and venture capital/private equity houses. Debt and working capital
facilities (loans and overdrafts/invoice discounting) are typically
provided by a bank and are the cheapest form of finance. Equity
investments are most frequently provided by a venture capitalist/
private equity house.
A typical funding split is as follows:
Typically providing 50/60% of the total funding need, the bank will have security over the
assets of the business acquired and will require to be repaid in priority to the venture
capital investor. Accordingly the bank profile is one of lower risk and therefore will
command a lower reward structure.
VENTURE CAPITAL / PRIVATE EQUITY PROVIDER
May typically put in 40/50% of the finance required for the MBO, they will stand behind
the bank and therefore require a greater level of return. They will achieve this by
subscribing for a % of the ordinary share capital of the business alongside management.

Low MANAGEMENT
Bank
Typically put in the smallest quantum of funding but who stand to make the greatest
Venture Capital / capital gain. The financial characteristics of an MBO therefore present management with
Private Equity Provider the opportunity to acquire the business they are running, financed largely by money
Risk / Return provided by external financial institutions with repayment of that finance flowing from
Management the profits generated by the business acquired and/or on ultimate sale.

High
4.
Why do management teams undertake MBO’s?

The main reason management teams undertake MBO’s is to This simple model assumes the business is acquired for £20m
make a significant capital gain from a relatively modest personal financed by bank debt £12m, venture capital investment £7.5m
investment. & management £0.50m. For their investment, the venture capital
investor in this example takes a 50% stake in the company. Let us
Here is an example: assume that after 3 years the business has doubled its profitability
and an offer to acquire the business is made and accepted at a
figure of £40m.

£million Day 1 Repaid in Period Year 3 Sale

After repaying the bank £6m (with an additional £6m having been
Purchase/ Sale Price of business acquired * 20.00 40.00 repaid to the bank over the 3 year period from cash flow) and the
venture capital investor £7m in respect of their outstanding loan
Financed by: stock, there is £27m to divide between the ordinary shareholders –
Bank debt 12.00 (6.00) 6.00 making management’s initial contribution of £0.50m worth 13.50m
Venture capital loan stock 7.00 7.00 – a very handsome return.
Ordinary shares 1.00 27.00
20.00 40.00 The equity (ordinary share capital) percentage required by the
Ordinary Share Capital Split
venture capital investor will depend on a number of factors and
Venture Capital Provider (50%) 0.50 13.50
negotiating the best deal for you is a key area where your corporate
Management (50%) 0.50 13.50
finance adviser has an important role to play.

Ordinary Share Capital Investment 1.00 27.00

* Ignores costs

5.
 1. The Basics continued

How to spot an MBO opportunity?

The opportunity for an MBO may arise for a number of reasons:

• the owner of a private company may wish to retire;
• shareholders may have conflicting interests leading to
a requirement for certain shareholders to be ‘bought’ out;
• a group may decide to sell a subsidiary because it has become • Warwick International is a manufacturer and • Asperity is the UK market leader in flexible
non-core or needs to realise cash;
• a receiver or administrator may wish to sell a business as a • Headquartered in the UK, it was part of the Sequa • The chief executive wished to continue to grow
going concern;
• an institutional owner of a private company may wish to
realise its investment;
• a company may not be well suited as a public company and
management may decide to take it private;
Warwick International Asperity Employee Benefits
distributor of specialty chemicals. employee benefit programmes
Corp of the USA, a conglomerate with revenues of the business whilst his fellow shareholder directors
$1.8 billion, and who considered the subsidiary to wanted to realise their investment in the company.
be non-core to the group as a whole. • Clearwater Corporate Finance was appointed by
• Clearwater Corporate Finance was appointed the shareholders to review the strategic options
by the management team of Warwick International open to them, advising on a £25.5 million buy-out
to advise it through an MBO process with the backed by Inflexion Private Equity.
management team wishing to take advantage of the • The transaction saw the chief executive realise 50%
opportunity to own the business. of his shareholding for a significant capital sum, with
• A $258 million buy-out was successfully negotiated all other shareholders exiting the business
and funded by Close Brothers Private Equity and a completely.
syndicate of banks led by HSBC • The buy-out as opposed to a full sale will enable
• The MBO allows the management to further realise the chief executive to share in the future capital
their aspirations for the business and the overall growth of this fast growing business.
potential of the group as well as sharing in the
capital value of the business.

6.
MBO versus IBO

Vendors are frequently appointing corporate finance advisers to
sell their companies for the highest price possible via an auction
process. This will involve the vendors’ advisers approaching trade
buyers and also private equity/ venture capital providers in order
to obtain the best offers for the business. Should the private equity
house be the successful bidder then the resulting acquisition will be
called an institutional buy out – an IBO.
In simple terms the difference between an MBO and an IBO is
that an MBO is initiated by the management team who will then
approach funders often including private equity providers whereas
an IBO is driven by the venture capitalist who will normally be given
access to management and typically then incentivise management
by giving them a share in the equity. It will be key for the private
equity house that management are prepared to continue to run the
business and they will want to ensure the team are on-board at the
earliest opportunity.
With an MBO, the management team, supported by their corporate
finance advisers, are in the driving seat. They will negotiate the deal
with the vendors and seek offers of finance from a range of funders
to support their bid. This ‘tendering process’ for the funding will
ensure management obtain the best terms possible for the MBO.
With an IBO, the private equity house will decide upon the price to
be paid for the business and will negotiate the deal with the vendors
and they will determine what equity percentage management
receive. The impact on management’s equity stake can be dramatic
ranging from c.15% in an IBO to potentially 50% or more in an
MBO process.

Your corporate finance adviser will guide you on

As can be seen, the end result of an MBO and IBO is similar in
how to maximise your position if you find yourself
that the business has a new owner and management will have a
faced with an IBO process.
share stake alongside a private equity investor. There are, however,
fundamental differences in terms of where the control and power
lies in the process.

7.

Will we be able to compete with a trade buyer?
Management teams may believe (or may be told) that they will be
unable to match the price that a trade buyer might pay for the
business and therefore do not pursue the opportunity. Certainly
there are times where a trade buyer with deep pockets will pay a
sizeable premium for a strategically important acquisition but this
is not always the case. Private equity institutions have increasing
funds to invest and are prepared to back management and compete
with trade buyers to win deals.
The fact that there is a competing MBO bid will often deter potential
trade buyers particularly if they are counting on management to
run the business for them.
8.
1. The Basics continued
There are a number of reasons why an MBO bid can be more
attractive than a bid from a trade buyer such as:
• it alleviates the need for the vendor (the seller
to pass on sensitive information to a potential
competitor;
• it allows the vendor to reward a loyal
management team ;
• management have a better understanding of the
business and therefore any initial offer is less
likely to be reduced through the process of the
sale;
• management can often act more quickly;
• the warranty obligations that a vendor will have
to enter into are likely to be less onerous when
selling to a management team;
• MBOs are often more acceptable to the
workforce. So the message clearly is ‘do not be
put off by a competing trade bid’.
 2. Key ingredients for a successful MBO

It is often said that the 3 most important ingredients for a successful MBO are management, management and
management. That is largely true and the importance of an experienced, committed and balanced team cannot be
underestimated. There are other key features however:

• an effective and well balanced management team • the buy-out must be capable of supporting
with the hunger and desire to take control of the required funding structure. That means cash
their future and back their own judgement; generation is paramount;
• a track record of delivering consistently strong • a suitable exit or sale opportunity for the
profit growth; business at some point in the future to enable
• a commercially viable business; management to realise the fruits of their hard
• a demonstrable growth strategy for the business; work. This is also essential for a venture capital
• a strong competitive position preferably in a investor.
growing sector;
• a willing vendor with realistic price expectations;

9.
 2. Key ingredients for a successful MBO continued

What is expected of the management team?

As we have already stated, financial backers will need to be convinced

that the management team has the necessary experience, can
demonstrate a successful track record, has a well balanced range
of skills and can manage the business independently i.e. without
the input of the existing owner. Should there be a skills gap, it
may be plugged by introducing an external candidate. Both your
financial advisers and venture capital backers may know of suitable
individuals if need be.
A typical MBO team will comprise of 3 or 4 individuals:
• Managing Director
• Finance Director
• Sales Director
• Production/Operations Director
Management will also need to convince their backers that they have
a sound growth strategy and that they are capable of implementing
it. It is also vital for the smooth running of the deal to appoint a
corporate finance adviser at the outset who will project manage the
MBO on a day to day basis, co-ordinate the various parties involved
and drive the timetable through to a successful conclusion.
How much money will we need to invest personally?
The team will need to demonstrate a high level of commitment
backed up by their personal investment. Financial institutions will
expect each member of the core management team to invest
personally with the team leader (typically the managing director)
usually investing more than other key team members.
The amount of that investment will be dependent on personal
circumstances and the extent of any existing shareholding in the
business. BUT a broad ‘rule of thumb ’is a sum of money which
equates to one years salary for each team member. It is quite
common for members of the management team to borrow money
from a bank in a personal capacity to finance their investment and
your corporate finance adviser can guide you on this aspect

10.
When should we approach the vendor?
Without a willing vendor the deal will not happen, so they will need
to be approached early on in the process.
It will depend on individual circumstances as to whether it is more
appropriate for you or your corporate finance adviser to make the
approach.
Prior to making a formal approach to the vendor it is eminently
sensible for your financial adviser to undertake an initial feasibility
study to confirm to you that any proposed deal will be viable and
supportable by financial backers. Dealings with the vendor need to
be handled carefully as the team will be employed by the business
during the MBO process and possibly thereafter should the deal
not complete.
Sensitivity is paramount. Until vendor approval to progress the
MBO opportunity has been obtained care should be taken to
observe your fiduciary duties to the shareholders of the business.
The timing and nature of the approach is a critical area and one on
which your financial advisers will guide you.
Why are exit opportunities so important in an MBO?
Equity providers need to be able to realise the value of their
shareholding at a significant capital profit often over a 3 – 5 year
time horizon. They will achieve this in a variety of ways:
• a sale of the company to a trade buyer;
• sale of the company to another venture capital
private equity house;
• management may occasionally be able to buy-
out the shareholding of the private equity house
through a secondary fund raising (‘Secondary
buy-out’);
• a flotation of the business on the London Stock
Exchange or AIM.
The most likely exit route will be a sale of the business to a trade
buyer and your venture capital backer will want to be satisfied
before investing that a pool of likely buyers exists and that your
business will be an attractive proposition to a trade buyer at some
future point in time.
11.
 3. The MBO process
Piecing together the jigsaw

Undertaking an MBO is a time consuming and complex process.

It involves many different phases with a whole host of crucial
elements needing to be pieced together carefully before the picture
is complete.

12.
AND

Whilst no two MBO’s are the same and the nature and timing of the
approach to the vendor in particular needs careful consideration,
the following is a typical sequence of events:

13.

Why do we need to appoint a corporate finance adviser?
A corporate finance adviser should be appointed at the outset
and will be wholly involved in all aspects of the transaction until
completion. The role of the corporate finance adviser in assessing
whether an MBO is viable is crucial. Any management team would
be well advised to ensure than an MBO is feasible at what should be
a mutually attractive price before entering into detailed discussions
with the vendors.
In deciding whether or not the MBO is credible, the corporate
finance adviser will consider the following:
• the likelihood of securing financial backing (by
being satisfied that all the ‘key ingredients’ for an
MBO are in existence);
• the maximum purchase price;
• the returns available to the MBO team for their
investment in the deal;
• the probable financial structure of the deal;
• the likely funders who will have an appetite for
the proposition.
14.
3. The MBO process continued
Once the corporate finance adviser has decided that it is a viable
proposition they will then advise on how best to handle the
negotiations with the vendor and may often approach the vendor
on the team’s behalf depending on the circumstances.
Key contributions of a corporate finance adviser should be:
• assessing the feasibility of the MBO; • negotiating the best possible funding structure
• advising on the format and content of the and packages;
business plan; • introducing the management team to other
• valuing the business; advisers such as lawyers and tax advisers etc;
• deciding on the nature of the approach and • monitoring deal costs generally;
negotiating the best deal with the vendor; • project managing the entire transaction through
• ensuring Stock Exchange regulations are to legal completion.
addressed if the vendor is a quoted company;
• selecting suitable financial backers;
• arranging and attending meetings with the
proposed financial backers and helping to
prepare presentations to them;
The MBO process can be an emotional roller coaster and
management will need to work very closely with their
corporate finance adviser often on a daily basis. It is therefore
vital to select an adviser you feel you can work with and who
will provide the necessary experience and support when
times get difficult – because they invariably will!
What will we need to include in a business plan? Why will we need tax advice?

The business plan is a crucial document. Its main purpose is to ‘sell’ Expert advice is needed before the MBO is legally completed in
the MBO opportunity to the banks and private equity institutions order to ensure the maximum financial benefit for the management
whose support is being sought. It should be completed as soon as team after paying income and capital gains tax and also to ensure
the owner has granted permission to pursue the buy-out. they are afforded necessary protection in respect of any tax
irregularities that subsequently come to light.
Management must take full ownership of the plan. However, the
corporate finance adviser will give invaluable input and guidance on Issues that need to be addressed are:
content. They will provide a framework for the plan and a critical
and constructive review of the plan and the financial projections • the availability of income tax relief on the
incorporated therein. interest paid on borrowing for personal
investment;
A typical business plan will include the following: • the structure of the transaction and the
requirements for any tax clearances;
• executive summary covering a brief overview of • payment of stamp duty;
the business and the rationale for the • VAT registration for the new company and
transaction; advice on the recoverability of VAT in relation to
• concise history of the business; deal costs;
• description of the products and services; • opportunities to minimise capital gains tax and
• profile of the management team; inheritance tax liabilities in due course;
• analysis of the business’s top clients and also its • tax indemnities from the vendor.
key suppliers;
• analysis of the market and key competitors;
• the company’s operations – its premises,
systems and employees;
• strategy for growth;
• historic financial analysis (last 3 years);
• analysis of the projections and their assumptions.
Remember the funders will monitor your
performance against them.

15.
 4. Timescales and cost

Completing an MBO can easily take between 3 and 6 months

and often longer depending on the complexities and the
willingness of those involved to take a pragmatic approach.

The overall costs of completing an MBO can be substantial and

will typically amount to anywhere between 7% and 10% of the deal
value. A corporate finance adviser will ensure that the majority,
if not all of these costs, will be contingent upon a successful
completion of the MBO, therefore protecting the management
team from any material personal liability. The amount of funding
raised for the transaction will also include sufficient to enable the
new company formed for the MBO to settle all its deal costs on
completion.

Occasionally vendors can be persuaded to underwrite an element

of the purchasers’ costs to reinforce their commitment to the
successful conclusion of the deal.

16.

Managing the business effectively post buy-out will be the
immediate priority. You will no doubt have a few tasks to
catch up on!
It is common for MBO teams to adopt a detailed task driven
100 day plan for the immediate post MBO period, often at the
instigation of the private equity house. Some commentators say
this is the period when many MBO companies achieve the most
because of the goodwill created by the news of the deal.
Change is always viewed with caution so you will need to explain
the implications of the MBO to your employees at the earliest
possible opportunity post deal and provide them with the necessary
reassurances. Usually contracts of employment will continue on a
similar basis as before.
Capital incentives like share options or similar, may be useful to
incentivise key employees, particularly those you will be relying on
to deliver your growth strategy.
5. After the buy-out
Customers and suppliers may need to be contacted to advise
them of the change. It is likely that your financial backers may insist
that any key customers or suppliers are advised of the deal pre-
completion to ensure business will continue on the same basis. Any
sensitive relationships need to be handled carefully to instil the
necessary confidence in the new ownership.
It may also be necessary to install new independent systems for
financial reporting etc in order to satisfy your financial backers’
information requirements.
A venture capitalist may also appoint a chairman or non-executive
director to bring relevant experience and plug any skills gaps in
the team.
And finally positioning the business appropriately and
planning for a fruitful exit can not start soon enough and will
be encouraged by your venture capital backer at all stages of
the company’s development.
17.
 6. Why use Clearwater?

We hope this guide has demonstrated how our practical

help can assist you in contemplating a transaction of this
type.

When choosing your corporate finance adviser we recommend

you consider Clearwater’s key attributes:

• our owner manager culture guarantees a
committed and entrepreneurial approach to each partner. This experience provides the clarity of
client’s needs;
• our independence means that a conflict of
interest with our clients will never arise;
• we have sold our own businesses in the past and
sat in the hot seat and completed our own
MBO! – we know what you will be going through
from first hand experience;
• we have a track record of done deals and a
reputation for successful transactions that
provides our clients with an early endorsement
for their business and strategy;
• we have received award-winning accolades from
the industry endorsing the quality of our work;
• our expertise in initiating transactions sets the
standard for deal origination in the mid-market;
• Your deal will always be led by an owner
thought needed to make deals happen, free of
the bureaucracy and conflicts which burden our
peers;
• Your deal will be supported by one of our
research analysts. This provides a real difference
for our business and access for clients to inside
knowledge of strategic partners whether
acquiring, seeking capital or divesting; This guide provides the basic process of an MBO. For
• Our membership of the IMAP cross border additional advice relating to your business, we are happy
network provides quality research on and access to discuss your circumstances in a more personal, yet
to overseas buyers and investors from around confidential and obligation free manner. Please visit our
the globe; website or contact your regional office to speak to an
• Fees are normally success orientated to assure experienced adviser.
you that we are prepared to be judged by our
results.

18.
 7. Clearwater’s expertise

XLN Telecom Eden Supported Housing Asperity Employee Benefits The Dental Buying Group 1st The Exchange

ECI Partners Sovereign Capital / Management Inflexion Private Equity Synova Capital LDC

Secondary MBO of telecoms reseller MBO of company offering supported Institutional buy-out of employee MBO of the Dental Buying Group Institutional buy-out of a technology
living to adults with learning difficulties benefits provider provider

Clearwater Corporate Finance advised Clearwater Corporate Finance advised Clearwater Corporate Finance advised Clearwater Corporate Finance advised Clearwater Corporate Finance advised
the management of XLN and assisted in Newco for Sovereign Capital the management team and assisted in all Synova Capital on its backing of an MBO the management team and assisted in
negotiations negotiations of the Dental Buying Group negotiations

Zenith Provecta Denby Pottery Beck and Pollizer Britton Group Teaching Personnel

Morgan Stanley Valco Capital Partners Hermes Private Equity HSBC Private Equity Graphite Capital

Management buy-out of company Refinance of casual tableware Quaternary buy-out of engineering Disposal of extrusion and plastic Sale of provider of supply teachers and
offering support services for company manufacturer services business packaging manufacturing specialist teaching assistants in England and Wales
car leasing

Clearwater Corporate Finance advised Clearwater Corporate Finance advised Clearwater Corporate Finance advised Clearwater Corporate Finance advised Clearwater Corporate Finance advised
Barclays Private Equity on the transaction the management team Hermes Private Equity the shareholders and assisted in the shareholders and assisted in
negotiations negotiations

19.
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