Management buyouts (MBOs) were hit hard by the recession but the stage looks set for their return.
"I think MBOs will come back into vogue in 2017," says Mark Collins, partner and head of transaction services at KPMG Ireland.
“For a start, there is a good level of funding out there, including debt and private equity. On top of that, we have a lot of owners who might have expected to exit at age 60, but who have had to wait on until they were 65 or 70 before being able to do so, as a result of the downturn.”
Many have only recently emerged from the fire-fighting mode required during recession. “To sell a business you need a track record of three or four years’ fairly steady growth, and we are only now starting to see a number of businesses getting to that position,” says Collins.
Business owners may only now be in a position to sell, but management teams are only now in a position to buy too, as the funding environment improves.
“While there has been very little MBO activity over the past couple of years, it’s back once more as an option in some of the deals we are handling. It may not be the way those companies go, but it’s an option once more,” says Michele Connolly, partner and head of corporate finance at KPMG.
Finance options
"I think we will see a very strong return of the MBO this year," says Anya Cummins, partner in corporate finance at Deloitte. "The two ways of funding an MBO – debt and equity – are both very strong right now, including banks and alternative lenders. And as well as domestic private equity houses, we are also seeing very strong interest from UK private equity funds looking to back strong management teams here. If anything, post-Brexit, that interest has grown."
Rather than the traditional MBO, in recent years it has been much more common to see a private equity fund tabling a deal in which the management team is incentivised to stay via the provision of an equity stake.
Deals of any sort will only be done where the expectations of owners are reasonable however, says John Higgins, managing partner of EY’s Cork office and its head of transaction advisory services.
“Departing owners often have overly high expectations that can’t be met in terms of finance raised. And there are still some problems in this area, including a property hangover. Those debts are still there. They are getting lighter, but only gradually. Over time that should be eased by the lengthening of debt terms, and, ordinarily, inflation would take care of the rest. But we are living in a period of sustained low inflation, which is not helping matters on that front, and a lot of small- to medium-sized businesses are still struggling under a weight of debt, especially in retail.”
Consequently, both owners, and prospective management buyers, need to tread carefully. "It must be the best structure for both parties," says Katharine Byrne, head of corporate finance at BDO.
Loan books
“At the moment a lot of banks are looking to increase their loan book, which is good, but the risk is that some of these businesses will look to gear up too dramatically, to a point where, if there is a blip in the economy, they may find that hard to withstand,” she says.
As well as the pillar banks, which she believes have been lending sustainably, the market has seen the return of mezzanine and unitranche finance over the past three years, as well as the advent of private equity funds.
This newly diverse funding ecosystem is to be welcomed, reducing, as it does, the Irish business sector’s traditional overreliance on bank debt.
The number of funders out there has also given management teams increased confidence in their ability to attain an MBO. However, those attempting to discuss such an issue with shareholders must act with caution. “The issue for the management team is that if they are the first to express an interest, there is a potential risk to their own jobs,” says Byrne.
On the other hand, the risk to the seller of selling to a management team is that it may involve a phased buyout, which is more risky than a trade sale.
“Equally, for sellers it can be very flattering to have someone approach you with an offer, but very complex to understand the term sheet in front of you. What can appear like a very high valuation might not necessarily translate into the best return for you. It’s important for shareholders to take a step back and get advice,” says Byrne. “There is no shortage of funds right now, but care and caution is required especially as Irish businesses are used to dealing with bank debt only.”
Getting to grips with the funding landscape will become increasingly important as market valuations are restored.
“MBOs are starting to happen again,” says Paul Keenan, executive chairman and founder of Capnua Corporate Finance.
“In the recession, it wasn’t just valuations that fell, but business turnover did to. Now we are getting back to more normal levels of value and profitability.”
There are demographic drivers too.
Business owners
“Most people set up a business in their 40s and it takes 15 years to establish and build it up, before they typically think about selling. Many business owners are getting to that stage now, which is making it a good time to look at MBOs and a good time, I think, to sell. For a start, there has never been so much money out there to fund deals. Thanks to the actions of the NTMA and ISEF, we have a range of private equity houses now active in the market. And, for a business owner in their 70s, it is possible that you are becoming more remote from the business in any case and that it is the management team that holds the key customer relationships.”
For the management team looking to buy in, he too recommends getting confidential third-party advice before broaching the subject. “We can come up with rough valuations, and the ways in which a deal can be structured. Once you have established these you can go back and ask the question of the owner with more confidence,” he says.
From a seller’s point of view, what you get with an MBO is certainty, he says. “You get reduced warranties and indemnities and, while you may get less than in a trade sale, you were going to have to give something to the management team to incentivise them to stay for a trade sale in any case. And now, with most businesses having returned to a more normalised level of turnover and profit, you have better visibility of the next three to five years, so you know you’re not leaving notes on the table.”
