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Why you should use Corporate Advisers when structuring a company sale

4th Sep 2019   ·   Andy Haigh, Partner at BHP Corporate Finance   ·   Insights

To someone contemplating a buy-out, their skill will be running it, not the transaction itself. It’s therefore invaluable to have someone onside who is an expert in precisely this. Two fundamental aspects that the lead advisor might be asked to consider are:

  • on the buy-side; appraising the appropriate type of finance to support the transaction, putting together the funding package and advising on the new shareholder arrangements, and/or
  • either on the buy or sell-side; providing guidance on the structure of the consideration, advising on price and the terms of any deferred consideration

Market conditions are such that there are currently a wide range of funding options available to management and vendors looking to structure this type of transaction. The pricing of products offered by alternative debt finance providers such as ThinCats, reflect the nature of the transactions and type of lending they have an appetite for (typically it is cashflow rather than asset-led).

Assuming a debt-funded transition, let’s look at some of the elements within the transaction where the adviser can really add value.

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Structuring the package

Like any type of debt product, it blue venn concept 2.jpgcan be easy to over-borrow, with the business taking on more debt than they are able to pay back. Appraising the right amount of borrowing is therefore a key element of the adviser’s role: this will include how much the company can afford to pay back in any given year, allowing some leeway to take into account, for example, the covenant requirements of the funder and possible periods of weaker trading.

 

Allowing an appropriate degree of flexibility can make the difference between a successful transition and one that, at best, struggles. For example, not every business has a linear cashflow profile: earnings can be seasonal, so if a funder is making linear assumptions, the borrower is likely to face cash flow and covenant tightness during certain periods. In this case, borrowers would benefit from working with a funder that is able to create a bespoke structure that takes into account the variability of the business’s cashflows. If the product can be made specific to the deal while meeting the parties’ objectives, it is likely to lead to a greater chance of future success. An adviser should also work with the chosen funder to put in place an appropriate covenant suite that works for the funder and takes into account the specific circumstances of the business.

Price determination comes in part from the skill and experience of the adviser. In that respect, it’s subjective but can be reinforced by benchmarking and other traditional forms of business valuation. Alongside this, you need to factor in how much funding the buyer can realistically raise remembering that this may be derived from multiple sources, including vendor deferred consideration.

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Deferred consideration

How to structure deferred payments is an important aspect of the deal, especially where you have the demands of a new external funder.

In a debt financed transition for example, it’s unlikely that the seller will receive all their consideration upon completion of the transaction. Inherently this leads to an element of risk, as any element of deferred consideration will often be lower down the capital structure than a new funder. A vendor may have further value embedded in the business, likely in the form of an equity stake.

Sellers often have quite fixed views on deferred payments, sometimes based on predictions of high short-term growth. However, growth as a result of changed ownership often takes longer than expected to materialise, and therefore it would be better practice to calculate any deferred payments on historical, rather than hoped-for, levels of performance and cash flows within the business.

When it comes to structuring deferred consideration, the adviser’s role often involves managing the expectation of the seller whilst using the tools in their arsenal to create sufficient drivers to ensure that the deferred consideration is repaid on a timely basis, subject to the available cash flows of the business. This may involve taking advantage of better than expected cash flows post completion of the transaction and applying them to any outstanding deferred consideration.

A risk that a vendor faces when they sell their business in this manner and take an element of deferred consideration is how do they know that the new owners aren’t going to take the business in a new and, in the eyes of the vendor, potentially hazardous direction – going from managing car parks to manufacturing car parts, for instance, or paying the incoming CEO an inflated salary. A good adviser will ensure that the vendor retains a say in how the business is run until they have received all their proceeds. The vendor has ceded control but will have some protections in place such that the new management team are focused on ensuring the vendor(s) are paid out in full.

The ins or outs of the transaction

When choosing between an MBO or MBI, one of the challenges for the owner/vendor is making a distinction between an individual or individuals within the firm who is operationally capable of running the business day-to- day and candidates who can operate at a more strategic level. Raising finance, for example, will mean that the business has at least one additional, external stakeholder that the business will be accountable to, and it requires that management have a wide and varied skillset to manage this.

MBIs tend to be significantly riskier than MBOs because they involve an incoming manager or management team who perhaps do not know the business as well and may not even know the sector particularly well.

Depending on the circumstances, MBIs may be the only option for an existing shareholder, albeit external funding for this type of transaction tends to be more challenging due to the risk profile for the funder.

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Maintaining an upward trend

Finally, part of the skill of structuring an MBO/MBI transaction is that you often want to create a scenario that ensures that the vendor or exiting parties remain motivated to provide guidance to the business and management post transaction: how do you ensure that all that skill and experience that an owner manager has built up over many years is not lost?

You may also wish to consider tying in key employees within the business who may not be party to the transaction. One option for this is to create an employee benefit trust (EBT). EBTs allow you to hold shares in trust until you have identified the right people to reward/incentivise within the organisation, shares can be allocated to specific employees later, possibly once certain conditions are met.

image001_Andy.jpgAndy Haigh, Partner at BHP Corporate Finance

Andy was interviewed by ThinCats. To speak to Andy directly, you can contact him at andy.haigh@bhp.co.uk

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