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by Jeremy Furniss - Wednesday, 29th August 2007

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Private equity investors that finance buy-outs do not do so out of any philanthropic interest.

They and their pension fund backers want returns. In fact, they want returns that out-perform most other types of investment.

And so to double the value within three years, your business will need to be capable of doubling profits – and them some – in the same period. No growth, no deal.

At least not funded by the private equity community that dominates the buy-out market. With a mature business, a debt-based deal might be best.

The management team is critical. While funders support a great management team in an under-performing business – they rarely back a poor management team in a terrific business.

Private equity houses aren’t foolproof but they have become more sophisticated when it comes to management referencing and due diligence. Think hard about whether you and your team have the necessary credentials to complete a MBO before you embark on this bruising and time-absorbing process.

Managers are sometimes keen to buy the company that they work for – but only because the only alternative is a new owner coming in or a painful restructuring of the business.

All of a sudden, a buy-out seems like the more attractive option. Forget it. If you want to ring a venture capitalist’s bell, you need to come across as ambitious for your business – and your own wallet.

An MBO is not a defensive measure – a private equity investor will need to see the dollar signs in both of your eyes before he or she considers backing you.

Appointing advisers is a good idea but there are only so many tasks that you should sub-contract to them. Your business plan isn’t one of them.

While an adviser can offer sensible guidance, it cannot be the architect of your strategy. I often come across plans that have been engineered by over-enthusiastic advisers.

It’s obvious to investors when the managers presenting to him or her had only superficial input into the business plan. Don’t do

Every investor is looking for the perfect management team: the natural leader, the energetic sales director and the effective operations manager.

However, it’s the finance person who takes on disproportionately greater importance. A good financial adviser will help share the burden, but a competent finance director, capable of keeping up with the transaction, can make a successful buy-out many times more certain.

Most buy-outs involve management raising a cocktail of equity (from the venture capitalist) and debt (from the bank). While the VCs are out there aggressively looking to invest their cash, banks continue to be unpredictable creatures.

I’ve had two deals in the last six months where a bank changed its mind on the day of legal completion. In each case, the credit committee challenged the best judgment of a senior member of staff at the last minute.

Fortunately, alternative funding was found for both deals, but only after an additional six weeks’ of hard graft. You used to be able to assume that, if you found the equity, the debt would follow quite easily. In the current climate, you should seriously consider finding the debt first.

Some purchasers feel that they can agree terms with a seller, suck them into a detailed due diligence process and, when the seller is most psychologically committed, look to drop the acquisition price by 15 per cent for spurious reasons.

If the seller caves in, management and investor are laughing all the way to the bar.

If the vendor politely (or not) shows the VC to the door, management are left high and dry.

So, managers, pick your VCs carefully and agree up front how you intend to deal with the price negotiations.

Sound advice that was first published in March 2004. Read more of Jeremy's contributions in our archive. As well as lots more about management buy-outs.

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