Management Buy Out - Advise

[Dominic Sibbring]

Hey Guys,

I am new here. I have signed up as I am looking for an appropriate forum to ask some questions regarding an MBO I am undertaking with my colleagues and as of yet haven't found many people who have been through the process. Hopefully, someone on the forum has or can share their thoughts or even point me in the right direction of where to ask my questions.

Question 1)

We are undertaking an MBO, the company we are purchasing is a service provider and has no tangible physical assets and essentially the staff are its strength. For reference, the business has been trading over 30 years and has a solid reputation in our sector. The seller has set the sale price at 3 x the company profits over a 3 year period which is approximately £500,000. This is to be completed in 3 years (2024) with an initial buy-in in 2021.

In the next 3 years, the company founder is leaving the company, alongside this, the accounts manager is also leaving. The core of our staff are in their late fifties and will be retiring shortly after the MBO completes. My question is if a venture capitalist or outside party would be buying the business under these circumstances, would they account for the loss of key staff and if so how does that affect a valuation?

 

[Paul Kelly ICHYB]

Why don't you all just leave the company and start a new one? Voila, no purchase costs.

The staff are the assets of the business and if they all go within 3 years (Assuming there are more than those doing the MBO) you have nothing or a lot less!

How much does the current owner earn a year? Maybe look at paying their salary for a year or two, but it sounds like you will be under pressure as you have senior staff leaving!

 

[Dominic Sibbring]

Why don't you all just leave the company and start a new one? Voila, no purchase costs.

The staff are the assets of the business and if they all go within 3 years (Assuming there are more than those doing the MBO) you have nothing or a lot less!

How much does the current owner earn a year? Maybe look at paying their salary for a year or two, but it sounds like you will be under pressure as you have senior staff leaving!

Hi Paul,

The brand is strong and has built up a reputation and solid order book for delivering quality projects. Alongside this, the business is listed on a number of frameworks that bring in a lot of work. Getting onto these frameworks is subject to several years of audits and compliance which wouldn't be possible for a startup business.

 

[Paul Kelly ICHYB]

Great, but your ability to delivery those projects may be reduced by the older/senior staff leaving.

Also, remember that there has to be some money left in the post after you buy the business to cover costs etc.

 

[Dominic Sibbring]

I

Great, but your ability to delivery those projects may be reduced by the older/senior staff leaving.

Also, remember that there has to be some money left in the post after you buy the business to cover costs etc.

I know this is my concern, the buyout team are capable of delivering the projects however senior members leaving concerns me enough to ask if the valuation should consider this. We have reserves built that will cover operating costs for the first few months of trading.

 

[IanSuth]

I was involved in an MBO and got stitched up like a kipper

It started just before the 2008 crash and the accounts manager was due to retire, she actually went off on a cruise in July 2008, in Jan 2009 she came back to help with end of year rather than us having to pay a lot to a new accountant - or at least that is what we thought

We shut the company end of March as otherwise we would have had to dig deeper in our own pockets as making a big monthly loss due to collapse in market and a company we sublet a floor of our office to going bust. We did a pre pack to ensure a proportion of use stayed in jobs (although we lost our investment in the MBO), suddenly the accounts manager resurfaced in paperwork to a tribunal claiming she had been redundant and there was a TUPE in place which meant the new company should pay her redundancy pay dating back to 1973. As she was also payroll and had shredded everything it was impossible to prove she had retired and the new owners put the cost of her redundancy (and the cleaner she roped in) straight onto our bottom line to be covered before we started getting any commissions.

I learnt 1 big thing - no matter how well you think you know people and get on with them in business get everything in writing - if it isnt written down and witnessed it doesn't exist is now my motto. The sums you are talking about are big enough to cause you personal issues so document document document - if you ask questions do so in writing and get the answers in writing. If you get a verbal answer, email them back confirming what has just been said, if there is ambiguity in an answer get it clarified etc etc

 

[Frank the Insurance guy]

Hi,

You really need professional advice from an accounting and legal perspective.

If a number of senior key figures are leaving, you need to consider:
1. What will they do when they leave - They have the contacts/relationships!
2. What is the potential impact on your business to lost business/opportunities

Can you structure a deal so that some of the Purchase price is paid on retention/growth of business at end of year 3, with the leavers not involved benefiting from the sale themselves being offered a Bonus/incentive at end of year 3? They can work on passing on their contacts and relationships in year 1 and 2 before leaving at end of year 2 - this then gives them an incentive to make sure they have a good hand-over to ensure a good year 3 and they can get their full payout/bonus.

Whatever you do - make sure its in writing and prepared by legal advisors!

 

[John Hemming]

These sorts of things are often quite difficult and a forum is not the best place to get life changing advice. A lot depends upon who is tied in to which deals and where the goodwill of the company can be said to be. 3 x net profit is not that high a figure and clearly takes into account some factors other than just profit. A price of 10x EBITDA is a normal figure for a stable profitable business that is not like buying a job.

 

[pentel]

The seller has set the sale price at 3 x the company profits over a 3 year period which is approximately £500,000.

The seller doesn't set the market price the buyer does.

I would have a very deep look at how the profit has been calculated. It is possible for a seller to massage the figures for a few year to show the company in its best light (as any seller should).

Look at all the potential costs that may be hidden or deferred,

Be very careful. Business is very hard at the moment with lots of turmoil in the market.

My question is if a venture capitalist or outside party would be buying the business under these circumstances, would they account for the loss of key staff and if so how does that affect a valuation?

They would definitely take this in to account. At that sort of profit level the typical buyer would be a competitor who has the infrastructure in place to continue as and when the key personnel leave (which will probably be sooner than you think)

 

[Paul Norman]

On the face of it, the asking price is not unusual.

However, you need to satisfy yourself of a few key things.

If the business continues exactly as present, you will take at least 3 years (probably more, depending on tax and funding costs) to recoup your cash outlay.

Not a disaster, if you are confident of being able to service the investment in terms of funding costs. But those are two key points on which you need certainty.

1. With the staff losses you anticipate, can you be certain of maintaining that level of profitability?

2. Are you able to pay any costs of raising the funds and servicing any loans whilst the business continues?

Depending on your honest self examination on those points this may be a brilliant deal, or no deal at all.

 

[SillyBill]

I paid 4.5x EBIDTA in a MBO, a significant while ago now!

You ought to be confident in your abilities (or teams) to replace the founder and recruit new blood in or you shouldn't do it IMO, that simple really.

To give you an insight into my mindset - I was very confident once the business was under my control I'd be able to release more value than the departing owner. Basically I felt I saw what they didn't. And incidentally that a number of staff (some very senior) would invariably have to leave (as they did) to allow me to bring my own people in and implement our own vision with a new strategy. Within 3 years we had increased net profit by 100% and turned over 30%+ of the staff in that time. The key ingredient you need to evaluate is what your team are bringing to the table as leadership and that will set the price. If you are looking to hold the fort at best then perhaps a conservative offer would be called for.

 

[Financial-Modeller]

...We are undertaking an MBO...

It sounds like you are committed to this, but what would happen to the company if the management team didn't buy it?

 

[The Byre]

My question is if a venture capitalist or outside party would be buying the business under these circumstances, would they account for the loss of key staff and if so how does that affect a valuation?

Quite badly!

MBO or just purchase by an outsider - companies are made up of people. If people leave, then there is less company to buy! Simples!

@Clinton of this very forum has written some interesting articles on buying and selling companies here - http://ukbusinessbrokers.com/gallery/ and I have done a couple of simple videos on the subject.

But you do probably need someone who understands this subject to hold your collective hands - apart from the usual lawyers and accountants. There are all sorts of pitfalls and gotchas in any company purchase.

My number one question is always "Why is this company for sale?"

If it is ticking along nicely and the market is healthy and growth is steady and bookable, why aren't the owners keeping it and trousering the profits?

BTW, we may easily be having a major recession very soon - give it a year or two max - coupled with rising inflation. Let that colour your thoughts, particularly if government contracts are involved and/or the projects involve projects that are major investments in someone's future.

Right now is a time to hunker-down and see what is left (such as buying opportunities) after the storm has passed.

 

[Karen Watkins]

In answer to your original question, if a venture capitalist or outside party would be buying the business under these circumstances, would they account for the loss of key staff and if so how does that affect a valuation?

.. the short answer is yes!, The value of the business will higher as a result of key staff in place (and retained), the value will dependant upon this, ie if retention is in place they can ask a higher price or multiplier, if not tread very carefully, brand and reputation is all well and good but if they are not tied, in the value will need to reflect this. It may be worth checking our the contracts as part of the DD.

I agree with the others in this thread that this is a complex situation, we've done a few of these over the last year, depending on where you are based, I can put you in touch with a commercial lawyer who can help you with this, is that helps? Initial consultation is free, so good advice guaranteed.

 

[perfumeryart]

Great, but your ability to delivery those projects may be reduced by the older/senior staff leaving.

Also, remember that there has to be some money left in the post after you buy the business to cover costs etc.

The older staff could also be hired as consultants for the first couple of years, giving the company time to train new staff.

 

[PugwashEQ]

Being really honest- whilst you may be right that the valuation would be effected by key staff leaving, in reality they would be locked in with an earn-out or similar.

In this scenario the shareholders are being pretty generous by funding the transaction for you- and you have three to five years to start replacing the key staff, which is a significant period

Being really honest you may all be MUCH better with an employee ownership trust- which doesn't necessarily preclude the really senior team from also having a separate shareholding.

If it helps, we'd be pleased to give you some pro bono advice- the scenario you are discussing is one we deal with on a weekly basis.