What makes a good buy-out target?

Many managers consider taking over the business they work for, but not every company is a suitable target for a buy-out.

Many managers consider taking over the business they work for, but not every company is a suitable target for a buy-out.

A question we are frequently asked by teams considering a management buy-out is whether the company is an ideal target for it. There are no hard and fast rules but certain factors do tend to be common. Outlined below are some of the issues that will help identify if your company is ripe for a MBO.

Strength of management
A strong, commercial and experienced management team is essential to ensure the transaction is funded. It is important to have a team that cover all of the functions of the business at a senior level, i.e. managing director, sales director, finance director and production/operations director. Members of the team may have dual roles in smaller businesses. On larger deals involving an experienced non-executive director with industry experience can add credibility to a MBO team during the fundraising.

Strong cash flow
Cash generative businesses are always better placed to perform a buy-out. Strong cash flow will enable the repayment of debt and interest in the highly-geared vehicle used to effect the MBO.

There may be unique selling points associated with a company that make it attractive to potential acquirers. For example, its competitive advantage giving rise to cost advantage or product differentiation or a strong sales or research team. In this situation the company’s positioning may make an MBO an attractive proposition.

Companies in stable, strong growth sectors are generally favoured over more mature sectors. If there is excessive competition or over capacity in the sector the company operates in, this may make it more difficult to obtain funding. MBOs in sectors that are perceived to be more risky, such as IT, are also sometimes difficult to fund.

Non-core subsidiary
Companies that no longer fit with the existing activities of their ultimate parent and group are always strong candidates for a MBO. Willing vendors looking to divest of such companies will usually offer the incumbent management a chance to effect a buy-out unless they perceive that a trade sale would be more beneficial.

Growth prospects
Companies with good growth prospects are more likely to be attractive to funders. Visibility about future performance, growth and cash flows are key to funding MBOs.

Retiring senior management and succession issues
The impending retirement of a majority shareholder can sometimes act as a catalyst for a MBO, whether it be family succession or non-related members of the management team. This in itself would not make for a successful MBO, but combined with some of the factors above greatly assist in achieving a successful buy-out.

Exit route
Careful consideration needs to be given to the proposed exit route for the MBO team. Exit from the business and realisation of the funder’s investment need to be considered at the very start of the buy-out process. A planned exit via a trade sale or secondary buy-out will make the MBO a more viable proposition for funders that are also looking for their own exit. Flotation onto PLUS, AIM or the LSE is also an option given the achievement of certain key milestones along the way.

It is important for managers looking to do a MBO to identify what factors make their company suitable for it. Seeking professional advice early can assist this process by helping to identify quickly whether an MBO is the correct route upon which to embark and to discuss the funding options available.

By Laurence Whitehead, MacIntyre Hudson Corporate Finance

Marc Barber

Raven Connelly

Marc was editor of GrowthBusiness from 2006 to 2010. He specialised in writing about entrepreneurs, private equity and venture capital, mid-market M&A, small caps and high-growth businesses.

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