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Tempting Ventures launched our first fund in April 2017. Since launch, we’ve made 6 investments that are now tracking £20m sales. Our recent investment supported the Management Buyout of a Virgin FastTrack 100 business.
When we met the management team their track record, drive and passion for the business together with their credible growth plan made a compelling case for investment. Post investment, we’ve been incredibly impressed with the strength of client relationships, quality of L&D platform, the value proposition of the proprietary technology and the collegiate company culture.
Post-deal, we thought we’d jot down a few of our thoughts on MBO’s in the recruitment sector.
When do Recruitment Management Buyouts make sense?
Management Buyouts (MBO’s) are a tried and tested way of allowing the majority shareholders of a business (often the founder) to cleanly exit the business whilst allowing the Management team to take the helm and drive the business forward.
From the Owners perspective:
The prospect of an MBO can make sense for a host of reasons. Perhaps the majority shareholder or owner wishes to retire? Perhaps they have other interests they wish to concentrate on? Perhaps the founder’s intentions have always been to sell the business at a certain value trigger and their preferred buyer is the Management team. Perhaps the management team's vision for the future of the business differs from the current owners?
In the last 15 years, I have been involved in several Management Buy-Outs where I have taken the view that the Management Team would be well served and motivated by the opportunity to take the business forward. As a seller, I have always felt that an MBO at a trigger value can incentivise the team to get there faster in the first place but can also avoid the beauty parade of potential buyers assessing the business and all the uncertainty for the existing team that comes with this. Equally, because the Management Team already works in and understand the business and the opportunity, it has allowed for a more streamlined due diligence process and has allowed the owners to exit cleanly without the need for an earn-out period that an external purchaser would likely insist on.
In MBO’s, because the owner understands and has an existing relationship with the Management Team they may also take the view that a staged MBO may be sensible, allowing the Management team to buy the founder out over time provided they hit certain milestones. Often a staged exit can be more lucrative for the founder whilst being more affordable for the Management Team.
From the Management Teams perspective:
The Management Team already understands the business, the client base, the candidate base, the recruiter base, the sector and the opportunity. Because they would be driving the purchase of the business they see it as an opportunity to acquire an asset they already understand and, more importantly, see it as an opportunity to purchase a business they will be at the helm of to drive forward.
There is less risk and uncertainty for the management team in an MBO than a purchase by an external buyer and likely more opportunity, as they will be able to negotiate their terms as part of leading the acquisition.
With renewed vigour and a solid business plan, an MBO should be a galvanising experience for the Management Team allowing them to work together towards a common goal post acquisition
Where the Management Team is at the helm of an established business with a reasonable level of Operating Profit it is normal that the team will go to market to access funding for their MBO. The owner will have expectations as to value and the Management Team will look to access funding to meet the owner's expectations from Private Equity/Venture Capital houses, Private Investors or Banks.
From the Investors perspective:
Personally, if a strong management team contacts me to discuss whether we would consider financing an MBO I generally find this a positive. It tells me that the team is motivated and proactive enough to try and forge an opportunity and believe in the business enough to wish to stay in it and commit to it for the next number of years.
The dynamic of an MBO often appeals to Investors. The Management Team has not only a bigger opportunity as a result of the Investment but also more equity. This contrasts with alternate Private Equity/Venture Capital Deal Structures.
To understand why Investors like MBO’s is to understand this dynamic. Put crudely, four popular investment structures used by Venture Capital houses in the recruitment space are:
1: Debt for Equity
The existing shareholders wish to move the business forward but the business requires investment in order to do so. A Venture Capital House takes a stake in the business in return for providing the financing to move the business forward.
Pros: The business is better funded to achieve its plans and create shareholder value and the Founders/Shareholders appetite for the business to succeed has not diluted, as they have not personally received payment in return for the Investment.
Cons: The existing shareholders have diluted their shareholding in order to secure the Investment. If they cannot execute on the growth plan this could be a demotivating factor, as they now own less of a business that has more debt. This is a risk for the Investor
2. Straight Equity Investment
The existing shareholders wish to sell part or all of the business in order to receive personal value for the successful business they have built.
Pros: Where the business is successful and cash generative, this is an opportunity for the Investor to acquire equity in a business that they believe will continue to grow, making for a good investment.
Cons: The existing shareholders have personally received a significant payment in return for their shares and if they are not exiting, and are continuing to run the business, the fear is that they may not be fully motivated to drive the business forward as they now have more money and fewer shares. Equally, the business is no better funded to achieve its growth plans
3. A blend of debt and equity investment
This is common in established recruitment businesses where the Founders and operational shareholders will look to access funding to grow the business in conjunction with selling some of their shares to the investor to derive reward from the value they have built to date
Pros: The Investor has funded the business to grow in addition to acquiring shares from the existing shareholders. If the Investor believes the team can continue to move the business forward this can make for an excellent deal structure allowing all shareholders to drive increased value into the business.
Cons: As above, the Founders now have less need and if they cannot use the debt effectively to fuel growth the investment will be vulnerable
4. Management Buyout
Management buyouts usually take the form of a straight equity investment (where the Investor finances the Management Team to exit the majority shareholder in return for equity) or a mixture of debt and equity (where the Investor also loans the business funds to enable the Management Team to achieve their aggressive growth plans.
Pros: The Management team have more, not less, equity as a result of the Investment and it is usually only the exiting shareholders who receive payment for their shares. Resultantly, the Management Team can only be more focussed as a result of the transaction and will be driving towards a future sale. Additionally, Investors are attracted to the business continuity that is associated with an MBO and the fact that the Management team will now be able to enact their growth plans with a sense of ownership and renewed vigour.
Cons: The Investor is assuming a lot of risk by backing the team in financing the payment to the exiting shareholders and in fuelling the business with financing to grow. Investors will often feel more comfortable if the Management Team are already minority shareholders in the business who are using the MBO process to leverage up their shareholding to work together towards a future exit. Where the Management Team is not currently shareholders, the Investor may ask the Management Team to invest beside them in order to get more comfortable with the risk profile of the transaction.
Our advice to teams considering an MBO:
Is Investment into the business in any context realistic? The Management team will remain the same so if the business isn’t already performing at a certain level it is unlikely an Investor will be buoyed by the prospect.
What is the opportunity? Prepare a detailed business plan that demonstrates what you would do with further Investment to include growth opportunities by teams and/or geographies and who you would hire to help you achieve your goals. Ideally, the plan should include the next three years financial projections with Investment.
Why now? As a Management Team, you will already have been in influential positions in the business so what has stopped it achieving your growth plans already. Investors will be keen to drill down on this question as it speaks to credibility.
Is an MBO realistic? Are you engaged in conversations with your existing shareholders about the prospect of acquiring the business? If there is no realistic prospect of an MBO Investors will be unlikely to engage.
Will there be a better return than seeking Investment to start your own recruitment business?
Are you sure? The gulf from being a Director to an Operational Shareholder is greater than some people credit. Are you sure that you want to assume risk and are you sure that you want to take the responsibility? I would always encourage a team to think this through before seeking Investment.
Should you be interested in finding out more about financing an MBO – contact the Tempting Ventures investment team: firstname.lastname@example.org