The answer to this question provides more answers than you may realise. It may seem like semantics, but we generally prefer to reference an exit, rather than a sale, as the latter, in our belief, serves to perpetuate the myth that a sale is a binary, all or nothing event, i.e., you either keep the business, or sell all of it, when it fact it is increasingly common for shareholders to divest of only part of their holdings.
Types of exit
There are four broad common types of exit:
- Sale to a management team (MBO or MBI)
- Trade Sale
- Partial exit
What is an MBO?
A management buy-out (MBO) describes a deal in which an individual or team who is or are already employed within a business (and who may already have some equity in the business), buys equity from an exiting shareholder(s).
Often when we suggest this as an option we’re met with a rebuttal on the grounds that either the management team wouldn’t have access to sufficient personal funds to complete the deal, or wouldn’t want to put their family homes on the line by having to borrow significant funds personally.
Our response in these situations is to point out that almost all MBOs involve some form of external funding, whether bank debt or private equity and that the contribution required of management is generally only that which is required to show that they have some “skin in the game”, i.e., enough to reassure a third party funder that they will be committed to the future success of the business.
There are a number of advantages to an MBO, compared to alternative exit routes.
- It can provide for a seamless transition to the next generation of management who are probably already in leadership roles within the business. The exiting shareholder may not want an abrupt exit from the business and an MBO can facilitate a staged handover whereby the former MD steps back into a non-exec or chairman role for a period of time.
- Selling to people who already know the business well, reduces the requirement for external due diligence (although the funders will still require some) and because the management team knows the true picture, warts and all, the prospect of price adjustments during DD should be largely eliminated.
- Often people are reluctant to go out to market as they either don’t want competitors getting wind of their plans, or don’t want to waste time with “tyre kickers.” A key advantage of an MBO is that no-one outside the business, other than advisors, lawyers and funders, knows what is going on and the rumour mill doesn’t have a chance to start turning.
- While not going out to market can help to keep a lid on things, it also precludes the generation of any competitive tension, which can significantly enhance the value achieved. People often ask us for a view on what their business is worth and while we can prepare detailed reports backed up by market evidence for the prevailing multiples, ultimately it is only by going to market that you truly know what your business is worth. With an MBO, there is therefore the risk of leaving value on the table.
- An MBO team will often need to invest in additional headcount; as they step up to director level roles, with the additional responsibility such jobs entail, they typically need to backfill their own posts. Due to this and the lack of operational or financial synergies, an MBO typically will never be able to pay as much for a business as a trade acquiror.
What is an MBI?
A management buy-in (MBI) largely mirrors an MBO, albeit that the purchasers in this case come from outside the business.
Often it comes into play when the incumbent management team aren’t interested in pursuing an MBO, lack the skill sets to lead a buy-out, or where a business is struggling and needs fresh blood in order to shake things up.
Occasionally, there may be situations where an existing management team wants to do a buy-out, but they feel that there is a gap in their team and seek to bring in an external individual(s) to bolster it.
In this case, the hybrid of the two deal types is referred to by the rather unfortunate BIMBO acronym (buy-in management buy-out).
- A typical MBI candidate will most likely be an experienced individual with a track record of growing and exiting businesses and who brings with them knowledge, contacts and experience that will be invaluable in helping the business to succeed post-completion. This can be particularly pertinent in a stressed or distressed exit scenario.
- As an MBI team will naturally be less familiar with the business than an MBO team and there is a risk that staff may not respond well to a new management culture, it can be harder to secure funding for an MBI.
A trade sale is the exit route that most people immediately call to mind when they start thinking about their plans. Simply, this involves the sale of one business to another business.
- A strategic trade purchaser will almost always pay more for a target business than any other type of purchaser. Whether it is to eliminate a competitor, secure valuable IP, expand geographically or sectorally, or simply to grow market share, a trade acquiror will generally see a more immediate upside than an MBO or MBI team and can therefore afford to pay a higher multiple.
- A trade sale generally comes as a result of a formal sale process in which numerous interested parties bid against each other to secure the target company, potentially driving the value up further. Where an unsolicited approach is received from a trade suitor, this will often be tabled at a sufficiently attractive level so as to avoid the temptation to test it in the market.
- An external purchaser will need to carry out extensive due diligence on the business and, even though there will be confidentiality agreements in place, it can be uncomfortable and time-consuming giving a third party access to commercially sensitive information about customers, key contracts, products, etc.
- In order to go out to market, you need to be properly prepared, with sales documents including an information memorandum (IM) and financial projections prepared in advance. The additional preparation required and the greater DD requirements can increase both the time and cost investment in the process, over and above that for an MBO.
While an MBO, MBI or trade sale typically leads to a full exit, for many business owners this all or nothing approach may not actually give them what they want.
In many situations we find that someone wants to sell, not because they’ve fallen out of love with the business or wish to retire, but because they’re increasingly uncomfortable with the risk of having the bulk of their personal wealth tied up in a relatively illiquid asset. This can lead to a sale for the wrong reasons and feelings of regret at having got out too early.
There are also often situations in which one or more shareholders may be keen to exit, but others wish to continue with the business.
Working out how to address these apparently contradictory goals is where the idea of a partial exit really comes into its own.
There are a huge number of private equity funds in the UK and Ireland, all of whom are looking for high quality companies and management teams to back.
These funds all have different mandates and investment timelines, but, broadly speaking, they seek to take equity stakes in private businesses and generate two to three times the return on their money over a three to five year investment period.
While some funds are purely growth capital focused (any money they invest has to stay on the balance sheet), the majority are comfortable with the concept of replacement capital, i.e., cash off the table to existing shareholders.
- Taking some cash off the table can liberate shareholders to make the big strategic decisions without the fear of how they’re going to pay the mortgage if things don’t work out.
- A partial exit can be used to refocus a boardroom in which some shareholders are looking for the exit door while others are still ambitious to grow the business.
- The PE investor will likely bring more to the table than just the money. Whether is it implementing proper corporate governance procedures, helping to refine the growth strategy, or assisting with introductions, as a shareholder in the business they will want it to grow and succeed every bit as much as the management team.
- For a typical MD, work can be a pretty lonely environment. Having an investor director on the board can provide a sounding board for ideas and someone to vent at when things aren’t going well.
- Introducing a third party onto the board can be a significant challenge for directors who are used to having the final word and who may not feel comfortable with having to answer to someone.
- The diligence process with a PE investor is typically even more rigorous than that for a trade sale. A trade acquiror will likely come to the table with well-developed knowledge of your business and the markets you operate in and this can serve to reduce the level of diligence they require. A PE investor, even if they have experience in your sector from past investments, won’t have the benefit of the same level of knowledge and may seek to address this through engaging commercial DD alongside financial and legal DD.
- The PE investor will need to see a clear path not only towards an exit within the next three to five years but also to an exit that provides them with a sufficient return on their capital. Most funds will typically look to make at least a 2x money multiple, i.e., invest £1m to get £2m on exit, and by necessity this tends to rule out businesses with modest growth prospects.
Floating the company on a public market is a less common means of achieving an exit than the three other examples referenced above.
Looking at Northern Ireland in particular, we have a very low number of listed businesses relative to the rest of the UK and one theory as to why this is the case is a fear, perhaps unfounded, that the burden of a listing both in terms of the initial cost and ongoing regulatory and reporting requirements, outweighs the advantages of being able to tap into public markets for follow-on funding and the boost to the company’s profile that follows a listing.
Awareness of the various options is key to achieving the best outcome for you and your business. Ultimately, it is only by taking the time to consider the specific strengths and weaknesses of your business along with your personal goals and timelines that you will be able to enter into a transaction process with confidence. A good advisor will take the time to understand your underlying motivation and not pressure you in committing to a particular course of action.