How to Write a Business Plan for a Management Buyout – What a Private Equity House Wants – Part 9


This is Video 9 of the “MasterClass
for Corporate Advisers and Entrepreneurs” on “Persuasive and Effective Business
Plans” … in which I’m going to discuss how to adapt your core business plan … to raise
money from a private equity house for a management buyout. If you intend to write
an information memorandum … to raise funds from a private equity house … to finance
an MBO (a management buyout) of your company … there are some additional points
that you should bear in mind. Most importantly … a good management team is
the prime ingredient in your business plan … that a private equity house will be
looking for. One person is insufficient. So it’s therefore essential that you
should have a team … and ideally the same team should have been working together
for a few years … so that they know each other well … and are therefore unlikely to
crack under pressure … when the going gets tough. However, you may run into various problems … when putting the management
team together … which you should resolve … before approaching a private equity
house. First, it’s essential that all the players upon whom the success of the
business plan will depend … must be included in the management team. Often,
to reduce the number of slices into which the cake must be cut … some essential
managers are excluded. This is dangerous … because the private equity house will
insist that all necessary players are tied into the deal. And without prior
consultation … some may not wish to be. And some may leave the company … because
they are annoyed at being initially excluded. Second, the private equity house
may not agree with you … regarding which members of the team should be primarily
responsible for managing the company. For example, the initiator of the deal …
or the main contributor to the management’s investment in the project …
may feel that he or she should be appointed to the principal management
role. However, to put together an M&A deal … is a different
skill to managing the company … and the private equity house may choose another
member of the management team to be the managing director. For example, if I were
to be part of a management team intending to do an MBO … I should be able
to put the deal together. But I wouldn’t choose myself to grow the company … as
I don’t have the interest … or the attention span … for such a long term
project. A management team should sort out these types of problems before
finalising an information memorandum for a private equity house. To attract the
interest of a private equity house… the management team must also have some money
to invest in the project themselves … or the capacity to borrow some. No matter
how good the prospects of a company under its management are likely to be … a
private equity house will want them to have some ‘skin in the game’ … so that if
the project fails … the managers will suffer financially. Only then will the
private equity house feel confident … that the management team is fully committed
to the success of the project. As an aside … I should say that if any of
your management team have a lot of money … they should keep quiet about it … because
the more you have … the more a private equity house will want you to invest.
There’s no point in asking someone to invest £200,000 if they’re
worth £5m. It won’t hurt much if they lose it … so, in
relative terms, a private equity house will want a much larger investment … to
ensure full commitment to the project. The main justification for an MBO … is
that the managers … once properly motivated …
can fulfill the head office function … without the previous overhead. Consequently,
the private equity house will cut all cost to the bone. They’ll therefore want
to evaluate whether each manager in the team will be able to function as an
entrepreneurial owner … rather than as a paid employee … expecting
all sorts of benefits … and whether they’ll be willing to take on the
personal risk of running a business which … if it goes wrong … could result in
the total loss of his investment … his job … his house … and possibly his wife … in
that order. It’s the ultimate ‘all eggs in one basket’
investment … and not for the faint-hearted. A private equity house will be
particularly interested in the character and independence of the proposed finance
director. He should not be just a friend of the proposed CEO … but must be strong
enough to resist the enthusiasm of the whole board … if he feels that its plans
haven’t been properly evaluated … or won’t be easily financeable. Grey hairs are good in
finance directors. They must have had experience of being in the trenches when
the bullets were flying. This is because smaller companies are often faced with
sudden and unexpected difficulties … which can be terminal … and need to be
immediately resolved … often by the finance director. For example, if your
computer systems go down for a couple of weeks …and you’re unable to pay
your invoices … and the company goes over its overdraft limit … the finance
director has to be credible … so the bank will believe that his ‘back of the
envelope’ calculations … are likely to be close to reality … and can therefore be
accepted … until the computer problem is resolved. The company must also be the
right type of company for an MBO … because the private equity house will load it
with a lot of debt … so the margin for error will be low.
Private equity houses are now much more specialised than they used to be … but a
company that would be suitable for a ‘plain vanilla’ MBO would be … non cyclical
… non capital intensive … and have high barriers to entry. You should have a
predictable free cash flow … and a strong competitive position in the
market … and also preferably be in a fragmented sector. The balance sheet
should be strong enough to support additional borrowings … and the
profit loss account should be sufficiently cash positive to pay the
additional interest. The company must also be capable of running as a
standalone business … without the assistance of its parent company … or
previous owners. Once you’ve decided that the forecasts in your business plan are
realistic … and you can defend them with confidence … you should not be persuaded
to increase them. A private equity house will sometimes be very enthusiastic
about backing an MBO … but say that it’s “disappointed with the forecasts” … and
would prefer it if you could “justify higher figures”. In an attempt to succeed
in raising the money … you may be tempted to increase your forecasts … in order to
secure the deal. You have to be aware, however … that these more optimistic
figures … will later become entrenched as a target for you and your management
team to meet … before you receive any share in the future profits of the
company. If you subsequently fail to meet the target therefore … you may find
yourselves working for several years … at very high personal risk … with not much
more than a basic salary. Finally, you should take a very tough line when the
negotiating with a private equity house. If you have an attractive proposal … don’t
be influenced by a friendly atmosphere … which’ll be about as friendly as a
‘smile on the face of a tiger’. If you can convince them that their association
with you and your company … will prove extremely profitable … they won’t mind in
the least that you’re clearly going to be very difficult to negotiate with … when
attempting to reach an agreement on the terms of the deal. They may consider that
you and your management team are real bastards. But that won’t matter at all. Because once the deal has been agreed … and the management buyout is up and
running … you’ll be their bastards … managing their very highly geared
investment … often in very competitive markets … and difficult financial
conditions … and you’ll have proved to them … that you’re exactly the type of
management team required to deliver the anticipated profits. That was video 9
where I discussed how to adapt your core business plan to raising money from a
private equity house. The next video, Video 10, will put all these first nine
videos together … and go through a business plan … and decide what type of
business plan headings we should have.

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