In the '80s, managers who bought out their own businesses could land huge windfalls. In a more sober 1996, however, MBOs aren't such easy earners.
Once upon a time there was a divisional manager, an average type of bloke who put in just enough effort to keep out of trouble, and whose division performed accordingly not disastrously, but not too brilliantly either. This division was a bit of a backwater anyway, not strictly related to the corporation's mainstream business, which is why one day top management decided to dispose of it. Rumours of this impending change gradually seeped into the consciousness of our manager, who felt somewhat unnerved by the thought of new and presumably more demanding bosses. Musing gloomily with his colleagues on this unpleasant prospect, he had a sudden brainwave. 'Why don't we buy out the business ourselves?' he cried, signalling to the barman for another round of drinks. 'We'd get top managers off our backs, and in a few years' time, when we floated, we'd make a fortune.'
Seized with unwonted energy, he and his colleagues swooped into action, convincing top management, appointing advisers, securing finance, mortgaging houses, and then working like billyo in their new company for two years so as to improve performance and thus ratchet up their share of the equity still further. Some of the executives left behind in the original corporation remarked scathingly on the sudden progress of the former division, but our manager was undeterred, pointing (quite accurately) to the sting of envy in their comments. Came the flotation, and the company was valued at twice the buy-out price. Our manager and his team, who owned substantial equity stakes, were multi-millionaires. 'We're rich! We're rich!' he crowed. Then he woke up.
And yes, it had all been a dream - an anachronistic dream of those happy times gone by when managers who happened to be at the right place at the right time could suddenly find themselves benefiting from huge windfalls. A more sober 1996, however, marks a new era in the rapidly evolving management buy-out (MBO) market, one which makes it much less easy for managers to find a huge crock of gold ready waiting for them on their exit from a buy-out.
Tim Lyle, director of Livingston Guarantee and a specialist adviser in buying and selling UK unquoted companies, outlines the market's latest phase: 'The most noticeable trend in the MBO and venture capital market is towards the bought deal and away from the traditional MBO,' he says. In a bought deal (also known as an investor buy-out, an IBO, or financial purchase), he explains, 'the venture capital firm now acts as principal, buys the target company outright, and offers the management team a much smaller stake. As a result, the venture capitalists can offer the vendor a higher consideration, and still get a good return, because they're hanging on to the equity themselves. The biggest winners are the vendors, who get higher prices. The losers,' concludes Lyle, 'are the management team'.
So farewell, then, to managers' dreams of stumbling upon untold fortune. Whereas in the old days, our somewhat bumbling divisional manager and his MBO team would have been in a doubly privileged position - buying the division at a lower price than other possible contenders, then receiving a majority stake into the bargain-these days incumbent managers have to participate in a highly competitive auction on equal terms with trade buyers and the venture capital firms. Where they do succeed, their share of the equity is likely to be 10% or less plus a ratchet (an agreed equity increase if targets are met) rather than 25% to 30% plus ratchet, according to Ken Robbie, research fellow at the Centre for Management Buy-out Research (CMBOR).
The new pattern is well-illustrated by the [pounds]37 million IBO, led by venture capitalists Charterhouse Development Capital and Advent International, of Zeneca's garden care products in late 1994. …