Buying a Business

Venture capitalists can assist you in buying a business either by a management buy out of the business you are running or a management buy-in of a suitable business in an area chosen by you.

Management Buy out (MBO) - Buying out your business

A management buy-out, or MBO, gives you the freedom to manage your business and a financial stake in the results. You would take control. The existing owners of the business might be attracted to this as a way to realise the value of their holding and step away from the business. In the process, they could protect the company's independence (an alternative, for instance, might be a trade sale) and reward the existing management team. This kind of opportunity is rare. Most managers only get a chance to participate in an MBO once in their career - which means that it is hard to find any management team that has substantial experience with the MBO process.

What is an MBO? It is a transaction where a business is purchased by its existing management team, with the help of outside investors like venture capital firms. The trend towards MBOs grew strongly in the 1980s and 1990s. Companies involved range from small family businesses to subsidiaries of big companies.

When an investor looks at an MBO opportunity, they will consider issues like the size of the company, its profitability, the calibre of its management, its market share and its cash flow.

If you are a business manager and see an opportunity, your first step may be to approach the existing shareholders to see if they are willing, in principle, to sell their company to you and perhaps others in the management team. The shareholders might also agree to pursue negotiations with you exclusively, giving you time to put together your offer. Many investors need this kind of agreement in advance before they can commit their support. Your business plan will sum up the opportunity. It should include:

• a description of the business
• an analysis of its competitors
• the company accounts from the past five years
• the accounts for the current year to date
• financial forecasts for the near future
• detailed biographies of the current management (the MBO team), and
• an organisational chart.

This clarifies the financial objectives of the MBO. Outside investors will want to know how the MBO team will buy and operate the company in a way to substantially increase the original investment. Once you have reached an in-principle agreement with the shareholders and have the support of investors, you can move on. You should document the offer and gain a written commitment from the existing shareholders to the terms of the deal - a 'heads of agreement', for instance. The transaction could be long and complicated. But it could end with you being in control of your own business as a manager and important shareholder.

Management Buy-in (MBI) - Buying into a business

If you see a business that might reward a new investment and a new management team, you should consider a management buy-in, or MBI. In these circumstances, a manager or team of managers from outside a company finds the financial support - often a venture capital firm - to buy the company. The manager who leads the MBI typically becomes the chairperson or chief executive.

Not all the finance goes towards the purchase of the company. There is also a substantial amount set aside for working capital, to fund new growth. In many MBIs, new managers take over the company to launch major new projects.

There are also hybrid versions of the MBI. One alternative is the buy-in buy out, or BIMBO, in which outside managers join forces with existing managers to buy the company. Another example is the BINGO, in which more than 25 per cent of the total funding is directed towards new growth rather than solely the purchase of the company.

The biggest factor in a successful MBI is management talent, which means your skill at putting the MBI deal together and achieving your aims once you gain control of the company. Potential investors will consider your direct managerial experience when they weigh up the investment opportunity. Some factors count against the success of an MBI. If existing managers are not included in the transaction, company morale can suffer and the business can stall during the MBI process. One way to avoid this dilemma is to consider the BIMBO - combining your role as an external manager with the talents of the existing internal managers. In general, MBIs prove difficult when the companies involved are too small to grow. Make sure your opportunity is large enough to provide scope for your skills and rewards for you and your investors.

Experience Counts

Consider looking for some experienced individuals to help you manage the MBO or MBI. Some New Zealand venture funds have a history of working on these kinds of transactions and may be able to offer you the advice you need to get started. Look for experienced individual managers as well. Some executives have been through the MBO/MBI process before and may be available to act as advisors or independent directors. This helps reduce the risk of a difficult endeavour, where you never really know what lies in store for you once you have assumed control of the business. In addition, the support of an experienced individual could help sway venture capital managers or other investors - and help you win financial backing for your plan.

How to proceed

If you consider the current management to be talented and effective, you should aim to include them in the process. Many outside investors prefer existing management to share in the transaction, in order to have the motivation to make the effort succeed. For some investors, BIMBOs now account for two-thirds of all their MBI deals.

In most cases, MBOs and MBIs involve the assumption of debt to finance the purchase. The debt can typically cover half the purchase price. One of your primary aims, then, is to keep that debt low by offering a conservative valuation for the company in question. Once the deal is complete, it becomes vital to generate strong cash flow to reduce the debt quickly.

Those who lead MBO or MBI deals usually put capital into the deal, which means you should be ready to commit your own cash towards your plan. If you succeed, you reap the rewards.

Hit the ground running

As soon as you complete the transaction, you need to start generating cash flow. Your challenge is not only to reduce debt but also to plan new investments that will achieve growth. Over time, you increase the value of the company.

The most likely executives to succeed are those who can demonstrate a record of solid management and entrepreneurial drive. They need a clear vision to take an existing company and transform it, creating a new company with a much greater value.

If that is you, then you should start planning your MBI now.