Weigh up the pros and cons of MBOs

The current climate in the IT sector is conducive to take-overs, but this is not always a positive move, argues Eddie Pacey

The IT sector is rife with consolidation: merger and acquisitions have increased as the prospect of Initial Public Offerings diminished, and there is an abundance of financiers and venture capital partners eager to take the plunge, hoping for returns at a later date.

There is nothing wrong with a business owner and shareholder deciding their time has come to take a well-earned rest after years of building up a business. The concept of a cash sale with a large chunk up front, deferred consideration or loans notes and a retained minority stake with more time on the golf course has a lot going for it.

But this does not mean that the seller can leave new owners to run the business unchecked. After all, there are still loan notes to be repaid and a retained stake that may yet yield a chunky further return. Therefore, there is a vested interest to ensure the business continues to deliver.

What of those who decide their boss has had enough and could do with taking time out? Do they engage external financiers before they make their move? Or is there a case for gauging the gaffer’s feelings first?

More important, what is their primary reason for making the move? Are they suddenly taken by a feeling of dread that the business direction is all wrong and the boss’s interest is on the wane? Or more commonly, are they convinced that they can run the business more efficiently and profitably than the current ownership and management?

And what of those who fund the management buy-out (MBO)? Do they really know the business and its market? More crucially, do they know how relevant the current ownership is to performance, future profit and direction? Can they judge the management team that is engaging in the MBO and determine what their contribution has been to the success of the business, or how they will perform moving forward? Not as much, because they generally place their own people on the board.

There are enormous positives for successful MBOs, but not all of them carry a silver lining. It is true to say that in such cases, new management generally over-estimate their worth and contribution to growth and profitability. Add to this a lack of knowledge in terms of financial data and cost base, and you have a recipe for disaster when the excitement of a completed MBO takes place. Business plans are often exaggerated and wildly optimistic. Ultimately, this means that business direction and control suffers.

When figures do not stack up, financiers and banks get worried. It takes a special breed of character to recognise a problem and put it right. By then, regrettably, the onset of paralysis can be progressive and terminal, so it is vital that anyone thinking of engaging in an MBO gives it real consideration and above all recognises how the business ticks and operates, who pulls the strings and who controls the client relationships. Consider carefully before discarding totally the hermit that occupied the shell you are intent on buying, lest you end up with a shell with no soul.

Buying a business to make a killing before selling it on again in three to five years should not be a primary driver but a hopeful end. Increasing the scope, breadth, presence and performance of the business should be the only initial thought.