North East businesses are having to simultaneously plan for opportunities arising from a quick v-shaped bounce back from the Pandemic whilst at the same time being realistic and preparing for a bumpier recovery with further waves of Covid19 impacting the economy. As we progress through summer it appears more unlikely that Boris Johnson's hopes of being through the Pandemic by Christmas will be realised.
Uncertainty presents both opportunities and risks for business and this can be seen currently in the recent upsurge in discussions around management buy outs (MBOs) in the North East.
There are becoming more opportunities for management to buy their companies from the shareholders – they represent good value for money as there is not always a strategic trade buyer option available for every company. Also, for larger Groups wanting to offload some of their assets in order to realise money and focus on core activities, offering management to explore an MBO becomes a viable strategy.
As the most active Corporate Finance adviser in the region and having advised on many more MBOs than other firms over the years, we recognise there are other favourable market conditions for retiring vendors to sell to their management teams. There are many funders who can support MBOs with sound business plans and there are potential tax benefits for the vendors too. If planned correctly, MBOs may offer greater net value to the older shareholders as the use of employee owned trusts result in reduced Capital Gains Tax savings – though the Chancellor Rishi Shunak’s ongoing review of Capital Gains Tax may mean that this will also change in the near future.
Some things however do not change – the fundamentals of structuring MBOs remain the same. The deal valuation must be set to keep management motivated and to make sure all parties – existing shareholders, the MBO team, the funders and the company – all can get what they want or something close to it. For the company it should not be overburdened by debt payments and it should have plenty of headroom in its funding facilities to allow for future bumps in the road – which are all too obvious whilst we remain in a global pandemic.
This is where Earn outs become more important. They are a method to find a valuation acceptable to all parties using the benefit of hindsight. In its simplest form the earn out allows for future payments to exiting shareholders based on future events, for example the price is increased dependent upon the level of turnover or profits earned in the first few years after the MBO. If trading suffers after the MBO then it is arguable for the goodwill at the time of the deal to be reduced. We have also seen deal structures where the goodwill or deal price is fixed but the payment terms are flexible, and the vendors may have to wait longer to receive payments if insufficient profits are available. The level of earn outs may vary for each MBO – sometimes less than 10% of the deal price to over 50% in others. Every deal will be different – but the principles of addressing the deal structure remain the same. Ensure that your business plan and financial forecasts are prepared for the company to be resilient to have plenty of headroom. This will give a solid start to the business under new ownership and with oversight from a capable management team will ensure that the business can cope with whatever the future brings.
Steve Plaskitt is the head of corporate finance at MHA Tait Walker which has advised on more MBOs than anyone other firms in the North East in his eighteen years at the firm. In 2019 MHA Tait Walker won an Insider Dealmakers award for the MBO of Fabricom Offshore and in 2020 it has advised on the two largest deals in the North East in 2020 to date (including the sale of Orchard Information Systems Limited to MRI Software).
Steve Plaskitt can be contacted on 0191 285 0321 or steve.plaskitt@taitwalker.co.uk.
