Succession Blog Issue One – Should I Stay or Should I Go?
Business owners often ask us if there’s a chance they could exit their business and allow management to succeed them.
Managers can also be keen to find out if they can buy out their bosses. The replies to both are similar – make sure that you have a deal acceptable to both parties that can be funded, and a plan to attract the funding.
It is only then that the vendor should decide to stay with the business and continue to drive it forward, or to go and allow management to take over.
There should be consideration of the vendor’s minimum valuation price along with the existing debt of the business. This is the enterprise value that needs to be funded for the deal.
The enterprise value should be compared to the existing profits of the business.
EBITDA is commonly used as a comparison, as this is the closest estimate to cash flow generated by the company. However, in some industries where continual investment in capital expenditure is required, then this measure of profits often overestimates the level of cash available to service debts. A good rule of thumb is that an enterprise value that is 3-4 times EBITDA is serviceable.
The next part is to consider how this can be funded:
- New equity: attracted by a business plan showing growth.
- Debt: requires a business plan that shows the ability to repay the funding from current levels of trading.
- Non-cash consideration: typically the extraction by the vendor of a business properly to their own pension scheme, or the extraction of cash built up in the business before sale.
- Deferred consideration: a way for the vendor to fund part of the deal. Such deferred consideration could be a fixed amount or an amount dependent upon future performance.
The vendor should first consider with their adviser whether they could construct a deal on the above basis. They should also assess how likely it is to be funded before approaching management and offering them the opportunity of an MBO.
If the numbers don’t stack up, the vendor should sit down with management to plan how to grow the business. This is to ensure that an MBO would be a more achievable option at a later time.
The next succession blog will explore the merits of an EMI scheme as a way to help incentivise management to improve the business’ performance.
This article originally appeared on the blog of our member firm, Tait Walker.