21 December 2017
Most owner-managers are beset by issues around succession. The difficulty in helping owner-managers retire where they have no suitable family heirs, a trade sale is not the preferred (or likely) option and where the management team are not considered ready, has led to use of the two-stage buyout.
There are certain situations where the management team are keen to take control, but may lack a number of the usual requirements for a management buyout (MBO):
- They may be too young to have credibility with lenders and customers
- They may have a limited track record
- There may be gaps in the team
- They may have limited funds
Whilst these problems may be overcome by joining forces with an external investor, this can bring other issues and is often seen with smaller entities.
The two-stage buyout can be a pragmatic solution and provide owners with a chance to maximise equity value over time. It applies to situations where there is limited availability for new funding or where the introduction of private equity is not a realistic option (ie. it is simply too expensive).
A case study may help may to explain the process:
Brian ran a successful multi-site retail business. He had been in business for over 25 years, and had built the business through selective and opportunistic acquisitions to sales of £60m, making profits of around £1m a year. The operations required constant attention to detail and yet Brian would spend increasing time away from the business. Some staff felt his motivation had gone.
Ed was the Operations Director who had increasingly taken over from Brian in managing the heart of the business. Crucially, he had experience and had gained the confidence of Brian and their main suppliers.
Jake was the Finance Director. He was young and ambitious, having qualified with a major firm. He had established first class branch monitoring and control systems that had helped the business become more efficient and profitable.
A conventional management buyout would not work. The management team were not ready to run such a sizeable business and would not be able to raise sufficient finance to fully fund the purchase price in one step. In addition Brian was not quite ready to exit.
The solution was a two-stage buyout.
Discussions between all parties were initially cautious and concluded after a few months with Brian being prepared to sell the business to management, but felt that they were not yet ready to take full control. The management team were also keen to retain Brian.
A new company was established to buy the business and at a price based on a multiple of the earnings. Finance for the transaction was arranged with the company’s existing bankers.
Brian reinvested the major part of the value in the new company, retaining 60% and moving to the role of Chairman. The remaining 40% was split between the new members of the management team. A structure and agreement was signed to sell his remaining 60% to the management team within five years at a pre-arranged multiple of earnings (stage two).
So the two-stage buyout was able to achieve the following:
- Brian was able to extract cash immediately (the amount that could be raised)
- The tax treatment was agreed by the Inland Revenue on the proceeds of sale
- The new members of management were able to buy 40% of the new company, with the prospect of a considerable return over the five year period
- Brian would benefit again from the future sale under the second stage of the MBO
- Management ambition was satisfied and the company energised for the benefit of all of the shareholders
- Brian was able to ease the transition with the management team.
This is very much a case of all sides benefiting from the transaction. The transaction provided liquidity, motivation and tax efficiency, as well as easing the retirement path of the owner-manager. And at a fair value recognising he had built in the business.
So if you find yourself contemplating a sale to your management, but they are not quite ready, why not consider the two-stage approach? Contact one your local corporate finance specialists or fill out our contact form here if you’d like to discuss your options.
