Management buyouts

1. What is a management buyout?

2. Parties involved

3. Structure of a management buyout

4. Profitability of a management buyout

5. Negotiation stage

6. Post-MBO management

7. Exit or divestment

8. Seven sources of value creation for buying managers

9. Leveraged build-up (LBU)

1. What is a management buyout?

Buyout (MBO, MBI, BIMBO, IBO, LMBO, SBO)

Management buyout (MBO)

The company's managers participate in the acquisition
Less risk
Seller: large company or family business

Management buy-in (MBI)

Managers from outside the company participate in the acquisition
More risk
The seller is usually a family business

BIMBO (buy-in management buy out)

IBO (institutional buyout)

LMBO (leveraged management buyout) LBO (leveraged buyout)

SBO (secondary buyout)

 2. Parties involved
1. Sellers
* Subsidiaries or divisions of multinationals
* Family businesses without heirs

2. Financial investors (venture capital firms, private equity firms)

* Select and analyse interesting target companies

* Provide know-how in the negotiation and structuring of MBOs

* Evaluate and motivate management teams
* Draw up a business plan and make plans for the future
* Provide know-how in negotiations with banks
* Provide capital to invest in the acquisition of companies

* Provide know-how in post-acquisition management (planning, control,

decision-making, sources of value creation)
* Identify and negotiate exit

3. Banks
* Specific debt for acquisitions
* Post-acquisition monitoring

2. Parties involved

4. Buying managers
Motivations
* Develop a business project
* Control their own destiny
* Earn lots of money

Characteristics
* Demonstrates experience and effectiveness
* Willing to invest Î Commitment
* With ambition, initiative, motivation and high level of dedication
* Convinced of project’s viability
* Clear leadership
* Teams of two to five managers
* Age 35 to 55
* The 6 F's (focused, fast, flexible, flat, frugal and friendly)
* Short- to medium-term focus
 2. Parties involved

5. Ideal target company

* Positive and stable cash flow
Products with well-positioned brands
Products unlikely to be affected by future changes in technology
Activity unlikely to be affected by economic cycles
* Opportunity to improve management
Income statement
Working capital
* Low debt level
* Moderate need for working capital
* Moderate future investments in fixed assets / possibility to sell assets
* Assets as collateral
* Growth opportunities
* Opportunity to buy low => realistic price of shares
* Opportunity to exit (re-sell company) quickly and easily
* Sound and well-balanced management team

3. Structure of a management buyout

1. New company (Newco) created

* Capital
Buying management team + financial investor (venture capital)

* Financial debt (MBO debt)

a) Senior debt
Backed by shares and assets of the target company
Duration: 5 to 10 years
Combination of line of credit and term loan
b) Subordinated debt (mezzanine or junior debt)
Between the senior debt and the capital (risk assumed)
Higher interest rates
Junk bonds with no guarantees but high interest rates
Usually includes: warrants (purchase options)
and/or convertible debt
 3. Structure of a management buyout

2. Newco acquires the target company

3. Merger by absorption of Newco and the target company

Post-merger assets
Assets of target company
Goodwill

Post-merger liabilities
Capital of Newco
Liabilities of the target company
Senior debt
Subordinated debt

3. Structure of a management buyout

• Target

Fixed assets 6 Equity 7

Working capital 3 Bank debt 2
ASSETS 9 LIABILITIES 9
• Target + Newco

Debt / Equity = 2/7 = 0.29 Fixed assets 6 Equity 5

Debt / EBITDA = 2/3 = 0.67 Goodwill 6 MBO debt 8
Working capital 3 Bank debt 2
Value of shares of target company ASSETS 15 LIABILITIES 15
= (Multiple * EBITDA) - Debt
= (5 * 3) - 2 = 13
Debt / Equity = 10/5 = 2
Debt / EBITDA = 10/3 = 3.33
• Newco
Value of shares of target + Newco
Fixed assets 0 Capital 5 = (Multiple * EBITDA) - Debt
Cash 13 MBO debt 8 = (5 * 3) - 10 = 5
ASSETS 13 LIABILITIES 13
 4. Profitability of a management buyout

MBO case study (Exit 1, leveraged)

Year 1 Year 2 Year 3

Increase in sales 0% 0% 0%

Cost of goods sold / Sales 50.00% 50.00% 50.00% 50.00%

Other expenses / Sales 20.00% 20.00% 20.00% 20.00%

Depreciation of operating fixed assets 0.9 0.8 0.7

Capital expenditures 1.0 1.0 1.0

Accumulated capital expenditures 1.0 2.0 3.0

Value of non-operating fixed assets 0.0

Reduction of working capital 0% 0% 0%

% working capital over sales 30.00% 30.00% 30.00% 30.00%

% interest rate of MBO debt 7.00%

% interest rate of pre-MBO debt 5.00%

4. Profitability of a management buyout

INCOME STATEMENT Year 0 Year 1 Year 2 Year 3

Sales 10.0 10.0 10.0 10.0

Cost of good sold 5.0 5.0 5.0 5.0

SG&A expense 2.0 2.0 2.0 2.0

Depreciation 1.0 1.0 1.0 1.0

Earnings before interest and taxes (EBIT) 2.0 2.0 2.0 2.0

Interest 0.1 0.7 0.6 0.5

Extraordinary profits 0.0 0.0 0.0 0.0

Earnins before taxes 1.9 1.3 1.4 1.5

Income tax 0.6 0.4 0.4 0.4

Net income 1.3 0.9 1.0 1.0

 4. Profitability of a management buyout

BALANCE SHEET Year 0 Merger Year 1 Year 2 Year 3

Net fixed assets 6.0 6.0 6.0 6.0 6.0

Goodwill 6.0 6.0 6.0 6.0

Working capital 3.0 3.0 3.0 3.0 3.0
Total assets 9.0 15.0 15.0 15.0 15.0

MBO debt 8.0 7.1 6.1 5.0

Bank debt 2.0 2.0 2.0 2.0 2.0
Equity 7.0 5.0 5.9 6.9 8.0
Total liabilities 9.0 15.0 15.0 15.0 15.0

Debt / EBITDA 0.67 3.33 3.02 2.69 2.35

Debt / Equity 0.29 2.00 1.53 1.17 0.89

4. Profitability of a management buyout

CASH FLOW Year 1 Year 2 Year 3

EBITDA 3.0 3.0 3.0

+ Extraordinary income 0.0 0.0 0.0

- Income taxes -0.4 -0.4 -0.4

- Interest expense -0.7 -0.6 -0.5

- Capital expenditures -1.0 -1.0 -1.0

- Increase in working capital 0.0 0.0 0.0

= Cash flow available to repay principal 0.9 1.0 1.0

 4. Profitability of a management buyout

Profitability of the MBO: Year 1 Year 2 Year 3

EBITDA multiple 5.0

Enterprise value = EBITDA * multiple 15.0 15.0 15.0 15.0

Equity value = enterprise value - debt 13.0 5.9 6.9 8.0

MBO debt 8.0

Investor’s equity 4.0 80.0% 4.8 5.5 6.4
Managers' equity 1.0 20.0% 1.2 1.4 1.6
Total 13.0 100.00% 5.9 6.9 8.0

Managers' equity value without ratchet 20.0% 1.2 1.4 1.6

Ratchet (5% of shares) 5.0% 0.3 0.3 0.4

Managers' equity value with ratchet 25.0% 1.5 1.7 2.0

Managers' IRR 48% 32% 26%

5. Negotiation stage

• Negotiation among management team members

Monetary contribution
Who is included and who is not?

• Negotiation with sellers

Ethical behaviour
Price
Conditions

• Negotiation with financial investor

Percentage of shares
Incentives (equity ratchet, envy ratio, bonuses, salaries)
Board of directors
Control and monitoring
Exit or divestment (tag-along right, drag-along right)
Dismissal (unfair or constructive)
Business plan
 5. Negotiation stage

• Negotiation with the bank

Size and repayment schedule of loan
Interest rate
Commissions and fees
Debt ratios
Net financial debt / EBITDA
Net financial debt / Equity
Minimum level of equity
Investments and divestments
Dividends
Loans, collaterals and guarantees
Insurance, audits, etc.
Legal changes: bylaws, board members, stock structure,
demergers, etc.
Collateral

6. Post-MBO management

Debt servicing
Î Focus + discipline
Resources (human, productive and financial) dedicated to essential aspects

Increase in generated cash flow

1. Increase in EBITDA
Reduction of costs
Increase in sales and margins

2. Optimisation of asset use

Reduction of investments and sale of unnecessary assets
Reduction of working capital

Contribution of the venture capital firm

Control and monitoring
Financial know-how
Rigorous decision-making
Image and contacts
 7. Exit or divestment
Possible conflict of interest between managers and investor
Investor wishes to divest quickly (3 to 5 years)
Investor wishes to sell to the highest bidder
Managers may not wish to sell company

Return desired by investor

IRR > 15%
Exit multiple of original investment (x2)
3 years => IRR=27% 4 years => IRR=20% 5 years => IRR=15%
MBI > MBO

Possible exits
Trade sale => Sale to a strategic buyer
Management team purchases 100% from investors
Secondary buyout
Initial Public Offering (IPO)
Write-off

8. Seven sources of value creation for buying managers

Value of shares = (multiple * EBITDA) - bank debt

• Pre-acquisition stage
1. Select good target company

• Negotiation stage
2. Negotiate a low acquisition price
3. Leverage the acquisition
4. Negotiate good ratchet, envy ratio, bonus, etc.

• Post-acquisition stage
5. Optimise income statement
6. Optimise balance sheet

• Exit stage
7. Negotiate a high selling price
 8. Seven sources of value creation for buying managers

EXIT SCENARIOS Entry Exit 1 Exit 2 Exit 3 Exit 4 Exit 5 Exit 6

LEVERAGED ACQUISITION Optimise Negotiate
(capital = 5, debt = 8) Income Optimise good Ratchet
statement assets exit 10% 2+3+4+5

EBITDA 3 3 4 3 3 3 4

Multiple 5 5 5 5 6.5 5 6.5

= Enterprise value 15 15 20 15 19.5 15 26

- Debt 10 7 6.3 5 7 7 4.5

= Value of 100% of shares 5 8 13.7 10 12.5 8 21.5

Value of managers' shares
without ratchet (20%) 1 1.6 2.7 2 2.5 1.6 4.3

Ratchet 5% of shares 0.4 0.7 0.5 0.6 0.8 2.1

Value of managers‘ shares
with ratchet 2 3.4 2.5 3.1 2.4 6.4

8. Seven sources of value creation for buying managers

EXIT SCENARIOS Entry Exit 1 Exit 2 Exit 3 Exit 4 Exit 5 Exit 6

NON-LEVERAGED ACQUISITION Optimise Negotiate

(capital = 13, debt = 0) Income Optimise good Ratchet
statement assets exit 2.8% 2+3+4+5

PBIT 3 3 4 3 3 3 4

Multiple 5 5 5 5 6.5 5 6.5

= Enterprise value 15 15 20 15 19.5 15 26

- Debt 2 -2.2 -2.9 -4.3 -2.2 -2.2 -4.8

= Value of 100% of shares 13 17.2 22.9 19.3 21.7 17.2 30.8

Value of managers' shares
without ratchet (7.7%) 1 1.3 1.8 1.5 1.7 1.3 2.3

Ratchet 1.9% of shares 0.3 0.4 0.3 0.4 0.7 1.2

Value of managers' shares
with ratchet 1.6 2.2 1.8 2.1 2 3.5
 9. Leveraged build-up (LBU)

Acquisition of a platform company

Rapid growth by means of acquisitions

Buy-and-build strategy

Fragmented, immature industry

Catering, transport, hotels, restaurant, paper, printing, retail

Long list of targets for acquisition

Management team with expertise in acquisitions

Knowledge of how to integrate companies

Financial investor

Hands-on approach