Earlier this week, we co-hosted a really successful event with a focus on growing your recruitment business at RBS’s London offices. There was certainly a lot of food for thought for the delegates, and during the Q & A, and networking afterwards, a couple of topics regularly came up. One of those was, from both a vendor perspective & a management team perspective, what goes in to making a successful Management Buy Out (MBO), another was the importance and relevance of shareholder agreements.
Looking at MBOs first, with the upcoming changes in dividend taxation, our expectation is that some business owners will accelerate their exit plans on the basis that a clear exit route providing a large and certain capital sum taxed at 10% (assuming Entrepreneur’s Relief is available) will become more attractive when compared to an uncertain ongoing income stream taxed at rates of up to 38.1%, and only the possibility of a valuable exit at some point in the future. With that in mind, what makes for a successful MBO deal? In this blog, I look at that in some detail.
Key ingredients for a successful MBO:
- A business with a strong track record of profitability;
- An impressive management team. Someone who is strong on the financials is a must, but coverage of strategy, sales, marketing, HR and IT are also important. It’s crucial that those exiting the business don’t leave a big skills and experience gap;
- The client list is obviously a big issue. Ideally, revenue should be underpinned by contractual or similar relationships, and you don’t want over reliance on a small number of clients. All key relationships should be in the hands of people who will be staying with the business;
- Candidate databases, and information systems in general, should be demonstrably extensive and current;
- A plan for retaining the services of top consultants, even if it’s simply the continuation of an existing scheme, would provide backers with some comfort;
- Cash injections (or possibly the ability to pledge asset collateral) from the management team. From a lending bank’s perspective (and actually from HMRC’s perspective) they expect to see considerable amounts of “skin in the game” from the management team. This is understandable, if the management team don’t believe in the business enough to pledge significant sums (according to their circumstances) then why should a bank?;
- Vendor flexibility in terms of a deal structure might be needed. Even if banks are keen to support the management team, they may not be prepared to lend enough to meet the sellers’ price expectations. Any difference could be made up by vendor debt which would typically be sub-ordinate to bank debt in terms of the order and rate of repayment, but provided the business continues to flourish you will at least get that value out in the end;
- An unencumbered debtor book can really help to grease the wheels as it enables lenders to provide secured finance, in the form of invoice discounting (or even factoring). A £2m debtor book for example might typically have the potential to generate around £1.5m in terms of a cash injection from a lender. However, the post deal business would need to be able to show that it could sustain the debt service costs associated with running an invoice discounting facility;
- HMRC may need to be on board. They cast a sceptical eye over some MBOs normally where there is vendor debt involved, on the basis that they suspect the vendors may be simply be exchanging a stream of cash payments which are taxed as dividends for one which is taxed under CGT rules (i.e. at 10%). They basically look to ensure that normal commercial terms apply to the MBO in terms of the length of any vendor loan, the rates of interest paid, what is being put at stake by the management team, and any ongoing involvement of the vendors (the less, the better);
- Last, but not least, you need excellent accountancy & legal advisers, probably on both sides of the deal exhibiting a commercial and pragmatic approach – we can help you with this.
In my next blog entry, I’ll take a look at shareholder agreements.