Business Valuation: Management Buyout

How to agree a fair price between everyone involvedThe second blog (of an 11-part valuation series) guides you through a management buy-out.

 

So, you’re either an owner selling your business, or an employed manager buying in/out. Where to start?

Whatever the situation, it all starts with a valuation of the business (you can do that for free here). Both sides need to do this to see if there are any differences in view. There shouldn’t be, because the data input should be identical – if it isn’t, it’s best to find out why, because if a management buy-out (MBO) is going to fail, it’ll be because the owner suspects the management to have been massaging the performance statistics for a long time to overstate performance and asset values. So, seeing why there are any differences in view will eliminate this dangerous potential at the outset by getting both side to agree how well it performs and what it’s worth.

 

Making the business valuable for both sides

Bearing in mind that the sale price of any business is determined by what both sides are willing to accept, our advice here is that you both put in some effort to make it worth as much as possible – there isn’t a second chance to see proper value for your life’s work or for its potential. This may sound unfair – both to the management team that wants to pay as little as possible and will find it hard to raise the finance, and overly generous to the owner who wants to sell it for as much as possible – but there is a method in the madness: both sides have a stake in this being a valuable business.

Why?

Because if it isn’t a good business then the management team have questions to answer about how they’ve been running it, and the owner might want to have it managed to a better performance level before selling it, or hold out for a price that reflects what the management team should have achieved. And if it’s a good business, it should be reflected by a fair price and one that a lender will be happy to fund. Good businesses are always expensive and the bargains are usually a disaster.

 

Are your dials green?

(What does this mean?)

Look at your runagood BUSINESS DASHBOARD® and you'll see that it gives you two values: one is what it's worth today and the other is what it would be worth if all five performance dials were green. If you’re in the happy position of having all dials green, you will sell/buy/finance it with ease. But if you don’t have all green dials you have a choice between a quick sale (dumping it for less than it's worth), taking on something that’s going to be very hard work, or working on it for a while to achieve a higher price.

 

How can we do that?

If you were about to buy it yourself, wouldn’t you want a business that is already:

Winning new customers?

Retaining repeat customers?

Generating profits?

Working efficiently?

Operating productively?

 

And that's what the five dials show you: exactly how your business is performing compared to the top in your industry. Your potential buyers/lenders/investors will already know what ‘best’ looks like and you need to be matching their expectations.

 

Improving your business’ performance

If you have red or amber dials, have a look at our Performance Improvement modules that will correct matters – they take effect in 90 days. If you can wait a few months before making the sale, you can expect a good gain in value and make it easier to raise finance/investors. You can implement them yourself or get help from an online Coach, which starts at £3 per day. There are also government grants available to help with costs.

 

The best possible light – the sales prospectus

The next thing you’ll need to do is prepare a sale prospectus. This vital document sets out what the business is all about and casts it in the best possible light. It removes all adverse factors that have affected past financial performance and restates the accounts as if these things had never happened. You’ll also be removing costs that are uniquely attributable to the past and current situation and which will not exist once in the hands of the management team and their co-investors. So in other words, you’ll be presenting the picture as it would appear if your business were being run as a straightforward and highly profitable subsidiary of a corporate business.

 

What will it be worth? – the business’ market potential

The next step in preparing the prospectus is to map out the market potential for the next 3-5 years and show how the business is well placed to take a greater share. This will involve introducing some marketing strategies that you may not be currently implementing – see our Marketing Modules for ideas.

 

Then project what the business will achieve financially in the next five years, being sure to add in the effects of the new marketing that you are planning to introduce (see above) and taking out the costs that the business would not have if merged with another, or were run on a shoestring by its new owner/managers. You now have the true value of the synergy that the new owner will enjoy after buying the business. You can calculate this crudely by taking the average of the next five years projected profits and multiplying by five. This will produce a number very much larger than the numbers currently on your BUSINESS DASHBOARD® and you may well be alarmed by it. But don’t be – if you’re the buyer you’ve already worked it out, and if you’re the seller you need to work it out too to ensure you’re buying potential. What you’re looking at is the added value your business will have once sold.

 

Start negotiations

Now you both know how valuable the business really is you can start to negotiate. And this can deal not just on the price but many other issues that go to make up the final deal including:

 

Is the original owner going to keep some shares? This will keep the price reasonable and payments staged as both sides now have the common aim of making the business a success. Make sure that both sides have an exit by being able to sell their shares to one another as first option.

Where will the finance come from? Finance providers like MBOs because they’re very low risk, so there will be plenty of competition. Long term loans and mezzanine finance (mix of loan and equity) are good so long as the business is not over-geared and spending too much on repayments. Crowdfunding would be a good method as no other investor is dominant and you can go back for more funding ‘rounds’ with a clear track record. Use venture capital only as a last resort as the management will find themselves forced into very onerous terms. Remember, a venture capitalist’s aim is to sell the business as soon as possible for as much as possible and the pressure will be on from the word ‘go.’

Is the original owner making loans to the buying team? This is a good borrowing method as both sides will have the common aim of the new business being successful.

Will payments be staged? Always try for this to assist cashflow and to keep both sides committed to its success. 

Are payment amounts linked to the results achieved? A double-edged sword, as it helps cashflow, but has the potential for conflict. Sometimes it’s essential when there are issues unknown to both sides e.g. ongoing negotiations with a major prospective customer or an unresolved supplier dispute.     

Will the business occupy the vendor’s premises? This can be a good low cost start until the business has the strength to move out – but don’t overstay, as friction can arise between former colleagues who can become adversarial.

Will the business continue using any of the vendor’s services? This can be a good low cost start until the business has the strength to develop its own services – but don’t overstay, as friction can arise between former colleagues who can become adversarial.

Will the business be selling goods or services to the vendor afterwards? This has obvious benefits in the early months and years but the management team should work hard at making itself independent.

 

Agreeing a price

Once both sides have worked these out, you need to get together. You’re going to agree a price somewhere between the low and high extremes calculated above and adjust it according to the answers to the questions above. 

 

 

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Duncan Collins
17.06.2014