Management buy-outs in Britain—A monograph

38

Long Range Planning, Vol. 20, No. 4, pp. 38 to 49, 1987 Printed in Great Britain

0024-6301/87 S3.00+.0{) Pergamon Journals Ltd.

Management Buy-outs in Britain A Monograph Mike Wright, John Coyne and Ken Robbie

The purpose of this paper is to examine the impact of management buy-outs on U.K. industry, with respect to vendors, buyers, financiers and advisers. Buy-outs have affected not only the way in which the newly independent businesses so formed are run, but the phenomenon has also strengthened the range of corporate strategy tools available and has stimulated the development of a particular part of the U.K. financial services sector.

I. Introduction In September 1980 the ailing Alfred Herbert divested itself of its measuring equipment subsidiaries and an independent company, Melville Technologies was created. Press c o m m e n t at the time stressed the cautious role of the consortium of eight institutions which funded the £ 2 m transaction. The fact that the management team of five had initiated the purchase and contributed £30,000 for 20 per cent of the equity warranted only a passing reference. N o mention was made of the fact that this transaction represented a management buyout. In the subsequent 5 years the term 'management buy-out' had become commonplace with the financial press reporting almost daily on new cases. The buy-out market-place has developed considerably and is n o w a sophisticated element in the market for corporate control. Indeed, as may be seen from Table 1, management buy-outs have been more numerous than conventional parent-to-parent divestments in every year since 1982, although it was only in 1985 that the average size of these two types of transaction converged in monetary terms. In examining the impact of management buy-outs on U.K. industry the article is structured as follows. Section II examines the sources and characteristics of U.K. management buy-outs as a prelude to Section III which shows w h y a buy-out may be a Mike Wright and John Coyne are Directors at the Centre for Management Buy-out Research, University of Nottingham Institute for Financial Studies, and Ken Robbie is a Research Fellow at the Centre.

preferred corporate strategy option for the vendor. Moreover, it is important to recognize that no longer do buy-outs involve the sale o f subsidiaries in forced circumstances, but rather they occur as a natural means of corporate adjustment to changing environmental circumstances. Section IV presents some general results on the performance effects of buy-outs. Section V addresses procedural issues (the requirements for a successful buy-out, negotiations and sources of finance) and Section VI draws conclusions. An extensive bibliography of both academic and practical literature is included.

II. Sources and Characteristics of Buy-outs There are no government statistics on management buy-outs. Accordingly, the empirical results reported throughout this paper are derived from studies undertaken by The Centre for Management Buy-out Research. These studies include a comprehensive survey of all the providers of finance for management buy-outs I and these institutions also serve as a source of data on the buy-outs which have taken place. Management buy-outs are also identified by the Centre from monitoring of the daily financial press and from a regular search of the annual reports and accounts of the largest 500 companies in the U.K. Since many management buy-out transactions are very sensitive, by no means all are made public, so that reliance solely upon the financial press and publicly available sources could provide a misleading view of the phenomenon. Some divesting parents would not wish the buy-out to become widely k n o w n within the organization for fear of encouraging other subsidiaries to do the same! Some buy-outs from family-controlled businesses on the current owner's retirement may be low-key affairs with the business carrying on under the same name and with little externally visible change.

39

Management Buy-outs in Britain Table 1. Acquisitions, divestments and buy-outs, 1977-1986

Year 1977 1978 1 979 1980 1981 1982 1983 1984 1985 1986

Acquisition of independent industrial companies ~ No. Ave acquired £m £m 372 441 414 368 327 296 302 396 340 537

730 977 1438 1 265 882 1373 1783 4253 6298 12125

1 "96 2"22 3"47 3"44 2"70 4"64 5'90 10'74 18'53 22"58

Sales of subsids between industrial parent groups ~ Ave No. £m £m 109 126 117 101 125 164 142 170 134 158

94 163 1 86 210 262 804 436 1121 793 1410

0"86 1 '29 1 '59 2'08 2'10 4'90 3'07 6'59 5'92 8"92

Management buy-outs 2 No.

£m

Ave

13 23 52 107 124 170 205 210 229 270

26 50 114 265 31 5 415 1176 1500

0"50 0'47 0'92 1 '56 1 "54 1 '98 5'02 5"56

1Source." Business Monitor, QM7. 2Source." J. Coyne and M. Wright, Review of U.K. management buy-outs in 1985, Venture Economics, London, and Centre for Management Buy-out Research, University of Nottingham (1986).

It is possible to identify a number of basic characteristics in the U.K. buy-out market-place.

private' (where on buy-out a company ceases to be listed on the Stock Exchange). The most outstanding example of the former is the buy-out at National Freight Consortium (NFC) in 1982.2-~ Since the NFC buy-out there have been several privatization buy-outs from such as British Shipbuilders, British Steel, NEB and BL (Rover). Most interestingly the decision to break-up National Bus on privatization has led to the offer for sale of about 70 units. O f the first 25 sold, 17 have been in the form of management buy-outs?

Management buy-outs come from various sources (Table 2), with divestment of subsidiaries by U.K. parents consistently providing the largest share. Some of these buy-outs may be cases where the alternative is closure, something that was particularly true in the pre-1984 period, but this element in divestment buy-outs has declined in the last 3 years along with buy-outs on receivership (either independent companies or parents). The share of buyouts from family exits though varying between years has remained significant throughout the period. This type of buy-out is beginning to be seen as part of the development of a similar phenomenon in Western Europe, particularly France and West Germany.

'Going privates' have been an important feature of the U.S. corporate scene for at least a decade, and indeed in the United States the term 'management buy-outs' refers specifically to this type of transaction. 6

Such 'going privates' offer benefits from the reduction in costs of Stock Exchange listing and through tighter control from the replacement of a diverse set of owners by a tight group of management and financiers. Amongst other things investment opportunities are not wasted through management concentrating on the production of pre-determined levels of performance to meet strict dividend payment demands.7-v However, concern has been raised in these cases that existing shareholders may be disadvantaged by management

Decisions to retrench to home territory and remove problems of coordinating the activities of distant subsidiaries has accounted for a substantial element of buy-outs from foreign parents in the 1980s. By the same token, U.K. parents seem increasingly to be engaged in the divestment of their unwanted overseas subsidiaries by buy-out. An interesting, but as yet relatively small, part of the market-place concerns buy-outs resulting from government decision to privatize and from cases of 'going

Table 2. Sources of management buy-outs Pre-1984

1984

1985

1986

52.8 7.0 20.5 17.9 1.8 --

62.5 12-8 6.0 10.7 2.0 6.0

65.5 9.5 16.6 1.4 2.4 4.1

61 '2 8-2 10-2 3.1 2.0 15.3

100.0

100.0

100.0

100.0

(%)

Divestment--U.K. Parent Divestment--Foreign Family/Private Receivership Privatization/Going private Overseas divestment

Total

(%)

(%)

Source: Centre for Management Buy-out Research, University of Nottingham.

(%)

40

Long Range Planning Vol. 20

August 1987

buying-out at significant discounts aided in the United States by very advantageous tax treatment? .'° There is, of course a danger that managers perceiving the opportunity for such a gain could systematically understate performance so as to be able to purchase at a discount, although U.S. evidence, at least, does not support this proposition." At the time of writing the United K i n g d o m has only seen five cases of this kind of buy-out. The Haden buy-out in 1985 was used as a defence against a hostile predator (Trafalgar House), something which is also a feature of the U.S. scene. In October 1986, the senior management of McCorquodale failed in their attempt to mount a buy-out to fight offthe hostile bid from N o r t o n Opax, having failed to find an alternative White Knight. The buy-out of G o m m e in 1986 represented the first case o f a U.K. 'going-private' buy-out in the absence of a hostile bid. The attempt to do the same thing at Molins in 1985 had narrowly failed as a significant minority of shareholders feared that management might be effecting a purchase at a significant discount. Management buy-outs occur across virtually all sectors of industry and for the most part show a similar pattern to acquisitions and divestments (Table 3). However, there are some notable differences. In particular, buy-outs are seen to be

comparatively over-represented in the shipbuilding and vehicle sectors, in footwear and clothing, other manufacturing, and banking, insurance and finance. This distribution reflects particularly high levels of buy-outs in such specific areas as motor distribution and insurance. By contrast buy-outs are relatively under-represented in metal goods n.e.s, paper etc., wholesale distribution, hotels and catering, real estate and energy. A final, yet crucial, demographic feature of buyouts that warrants attention is the size of the equity stake held by the management team. Strictly speaking, for management to claim to have acquired the firm they should possess at least 50 per cent of voting equity. However, to the extent that management obtain a significant equity stake where none existed before, beneficial ownership effects on performance may be expected. Wright and Coyne ~ and Hanney 12 have shown that in about three quarters of cases management have a majority equity stake and in a further one eighth of cases management are the largest single equity holders. However, this level of equity holding decreases markedly the larger is the buy-out--as may be expected since the typical team of between four and six will have limited funds though performance related ratchets can increase their share. An increasingly c o m m o n way of dealing with this issue is to extend equity participation to second tier key

Table 3. Industrial classification of acquisitions, divestments and management buy-outs, January 1984-June 1986 All

acquisitions

05 15 18 21 23 24 26 31 33 36 37/8 39 41 43/4 46 47 48 49 50 70/5 81 82 82HC 86 87/8 90 999

Manufacturing (mixed activities)

Agriculture, forestry, fishing Extraction of ores and minerals Food Drink Tobacco

Chemicals and man-made fibres Metals

Mechanical and instrument engineering Electrical and electronic engineering, office machinery Shipbuilding and vehicles Metal goods n.e.s. Textiles

Leather and leather goods, footwear, clothing Non-metallic mineral products Timber furniture Paper, printing, publishing

Other manufacturing Construction Transport and communication

Wholesale distribution Retail distribution and repair Hotels and catering Real estate

Business and other services including leasing Energy industries Banking, insurance, finance

Total

Divestments No, %

Management buy-outs No, %

No,

%

0 9 3 37 22 1 41 15 93

0.0 0.7 0.2 2.9 1.8 0' 1 3.2 1.2 7.4

0 2 0 18 6 0 12 6 41

0-0 0'6 0"0 5"1 1.6 0'0 3'3 2.2 11 '4

2 3 2 15 3 0 21 16 45

0.4 0'6 0.4 3.1 0'6 0'0 4'4 3"3 9'4

108 8.5 11 0.9 52 4.1 22 1 "8 20 1.6 16 1.3 21 1.7 96 7.6 46 3.6 55 4-3 21 1.7 90 7.1 125 9.9 32 2.5 62 4.9 208 16.4 37 2,9 22 1-7 1265 100'0

34 3 15 5 3 6 7 34 12 11 11 33 20 7 10 41 19 1 359

9"5 0"8 4"2 1 "4 0"8 1-6 1-9 9"5 3"3 3"1 3"1 9'2 5'6 1 '9 2"8 11 "5 5-3 0"3 100.0

46 21 11 10 23 3 13 20 47 21 17 21 31 2 1 60 2 25 481

9"6 4"4 2.3 2"0 4.8 0"6 2-7 4.2 9.8 4.4 3.5 4'4 6.4 0'4 0'2 12.5 0-4 5.2 100'0

Source." Derived from M & A records of the DTI and MBO records at the Centre for Management Buy-out Research, University of Nottingham.

Management Buy-outs in Britain executives, which also has the advantage of bonding them to the newly independent entity. 1'13 In any event a small percentage stake in a large buy-out can nonetheless represent a significant increase in a manager's personal wealth if successful and thus produce marked changes in incentives.

III. Buy-outs and Corporate Strategy (i) Conceptual Issues The current extent of buy-out activity indicates a growing acceptance of sale to management as a tool of corporate strategy. However, the conceptual framework within which sale to management is seen as the most appropriate option is only recently being developed. Buy-outs on retirement may arise where there are no available family successors and be preferable to trade sales because of the vendor's desire to see the family name maintained for the business and where retiring owners wish to reward employees for previous commitment in buildingup the business. (For fuller treatment see Wright, Coyne and Mills, TM Chapter 2.) However, the main focus of attention in the summary presented here is on divestments, as they provide the overwhelming source of management buy-outs. Reasons for divestment through buy-out can be rather complex. The initiative may come from the parent, from incumbent management or from external predators or their representatives (Table 4). From a parental point of view a decision to sell a subsidiary may be taken following a strategic review; for example the activity may be relatively small and peripheral to core activities (a c o m m o n source of buy-outs). From a defen_sive point of view, a parent may wish to sell so as to protect the overall entity. The subsidiary may be marginally viable and pose a threat to the remainder of the group, or it may not u n c o m m o n l y he the most saleable part of the business, the proceeds from which can be used to rescue core activities. A parent may decide that it needs to take a strategic decision to get out of certain activities, even though they traditionally have been quite significant to its overall operations. To some extent, initiative by management and external parties may be considered as the mirror images of the parent's views. External bidders may want to expand into areas the parent is getting out of, or may wish to buy divested subsidiaries, for rationalization in order to protect its existing interests. From

41

incumbent management's point of view, they may be presented with an unexpected and exclusive opportunity to buy the business, or may have to protect themselves where they anticipate or are presented with the parent's decision to sell to a hostile external purchaser or to close d o w n the business. It may well be that management are aware that the business has higher potential than the parent currently appreciates and take action to exploit their advantage of an informational asymmetry by making a pre-emptive attempt to buy the business. Thus there are many facets to the buy-out which can be viewed for each of the p a r t i e s i n terms of offensive, defensive or neutral strategies. Irrespective of where an initiative to buy or sell comes from, certain conditions must be satisfied for a transaction to occur and a transfer of ownership to be effected. For a management team to be successful over an external purchaser the following must be satisfied:

VM>G>VE or

VM>VE>G where V is the valuation placed on the subsidiary or division and M, E and P refer to incumbent management, potential external purchaser and parent of the subsidiary respectively. If a parent's valuation of the entity is greater than or equal to that placed upon it by other potential purchasers it is not worth the parent's while to divest. Asymmetric valuations by the parties concerned may be expected to arise for several reasons (Figure 1). O f particular importance in making sale to management more likely are the effects on local reputation, speed of sale required, the contribution of incumbent management to the subsidiary and their control of internal information. Strategic issues in buy-outs have been addressed in more detail elsewhere. 1s-22 (ii) Intensity of Buy-out Activity In order to gauge the relative position of management buy-outs in U.K. corporate strategy an analysis was made of the intensity with which individual organizations resorted to buy-out and the intensity with which buy-outs were found alongside parent-to-parent divestment and acquisition activity. Such analysis enables a picture to be developed of the apparent extent to which manage-

Table 4. Strategic considerations on purchase evaluation Defensive

Parent

Need to protect overall entity

Subsidiary management

Threat to position

External bidder

Protect existing interests

Neutral Unwanted assets post strategic review Unexpected opportunity to buy Intermediary approach/unexpected catalyst

Offensive Strategic shift in corporate directions Knowledge of unrealized potential Strategic opportunity

42

Long R a n g e Planning Vol. 20

August 1987

Management of Parent Risk Preference of Parties Shareholder Control of Parent

Risk Preference Risk Avoidance

t t

Performance Effect of Sale on Overall Group

High Low Improve Fall

Performance Effect of Sale on Subsidiary Sold

Improve Fall

N/A N/A

Effect of Sale on Local Reputation

Harmed Improved

f

Quick Slow High Low

,I, t

Speed of Sale required by Vendor Management Contribution to Subsidiary

t

Valuation bylManagement of External Bidder

t

t

N/A N/A N/A N/A

f f f

t

f

f*

Financability of Sale

Easy Difficult

Strategy of Parent

Offensive Defensive

t

Subsidiary Management Control of Information

High Low

t

N/A N/A

Management of Subsidiary

f t

t* t

t

t t 4,

*Assumes Management Does Not Stay With Subsidiary On Sale, or Sale Causes Dissatisfaction. ?Direction of Arrows Indicates Increasing or Decreasing Valuation by Each Party

Figure 1. Factors affecting relative valuation of a subsidiary for sale ment buy-outs are used as a tool of corporate rationalization and of the extent to which corporations see both sale and acquisition as a natural and simultaneous search process designed to enable management to move towards an optimal configuration of assets. 23 January 1984-June 1986 was chosen since buy-outs could be comprehensively identified for this period and moreover it was a period during which corporate adjustments were taking place in many large groups. As regards intensity of divestment through buyouts, for the most part those firms divesting in this way only sold one firm to management in the period covered (Table 5). However, in 11 per cent of cases three or more buy-outs were concluded, with the most prominent selling parents being Sears (seven buy-outs in the period), STC (eight), Hanson Trust (at least nine) and CharterhouseJ. Rothschild (at least nine). Those selling four or more companies by buy-outs were Consolidated Gold Fields, G K N , Guinness Peat, P and O, R T Z , Unilever, Thorn EMI, Elbar Industrial, Arthur Guinness, BET, B T R , and British Shipbuilders. By utilizing the DTI mergers and acquisition records it is possible to identify those parents also divesting through conventional parent-to-parent divestment (Table 6). In the majority of cases parents divesting by buy-out have not engaged in parent-to-parent divestment. O f the one fifth which have done so, some have engaged in this activity intensively. By the same

Table 5. Frequency distribution of intensity of divestment 1 through management buy-outs (January 1984--June 1986) Frequency of M BO

Number of divesting firms in period

(%)

1 2 3 4 5 6 7 8 9 10 and over

192 27 11 6 3 3 1 1 1 1

78.0 11.0 4.6 2.4 1.2 1.2 0.4 0.4 0.4 0.4

Total

246

100.0

~lncludes divestment by U.K., foreign and state owned companies and by foreign operations of U.K. companies. Source: Centre for Management Buy-out Research, University of Nottingham.

token, it is possible to identify from DTI records a large number of parents who have engaged in parent-to-parent divestments but not buy-outs. At present there is little evidence on w h y parents may prefer one route rather than another, although limited case study material indicates a basic anathema amongst some parents to sale to management, iv This aversion to sale by management buy-out may be declining as parents become more aware of the relative trade-offs highlighted above in Table 4. Indeed, it is k n o w n that at least one intensive

Management Buy-outs in Britain

43

Table 6. Two-way frequency distribution of divestments and management buy-outs (January 1984-June 1986) N u m b e r of divestments 0 1 2 3 4

1

2

177 17 4 3 -

16 7 2 1 2

5

.

6 7

1 1

N u m b e r of m a n a g e m e n t b u y - o u t s 3 4 5 5 . 1 -

.

2 2 .

. -

2 1 . .

.

.

1

1 -

2 2

205 27 8 5 4

81 "3 10"7 3'2 2'0 1-6

1 2 252

0'4 0'8 100.0

1

.

.

No.

.

1

.

.

7

.

. -

.

Total 6

.

. .

.

.

. .

.

%

.

.

Source. Derived from DTI M & A records and M B O records from the Centre for Management Buy-out Research, University of Nottingham.

IV. Performance Impact of Buy-outs

divestor by buy-out listed above has revised its corporate thinking in this respect over the last 3 years! Parents engaging in four or more parentto-parent divestments over the period are BAT, Booker McConnell, Reed International, Richardson Westgarth, Unilever, Fitch Lovell, TI Group, Tarmac (four each); CH Beazer, International Thomson (five each), Brammer,-Thorn EMI (six each); and GKN, Central and Sherwood (seven each). Taken together, buy-outs and parent-toparent divestments have accounted for 11 sales in GKN and Thorn EMI, for nine in BET and for eight in Unilever.

The relative newness of the buy-out phenomenon means that it is as yet a little early to make firm and final conclusions on the performance impact of buyouts. So far, the results of only two studies have been published. Wright and Coyne 4 surveyed 111 buyouts, whilst Hanney 12examined 57 cases. A further extension of the original Wright and Coyne study is in progress, whilst a study of management buy-outs which have achieved a stock-market flotation is nearing completion.24 Beyond these studies, evidence on performance in U.K. buy-outs is limited to case study materiaF '25 and several profiles in the Financial Times over the last 5 years.

Acquisition provides the other side of the ownership transfer process. A search for an optimal fit of assets may take two forms. Firstly, an apparently appropriate target is selected or acquired, but which subsequently proves to have been a mistake. Divestment in whatever form provides a means of correcting such an error. Secondly, a target may be acquired simply because a particular part of it is required. The remainder may then be divested to recoup some, or on occasions more than the initial outlay. Increasingly, unwanted elements may be pre-sold before the deal takes place. Table 7 shows that most companies engaging in buy-out activity did not acquire in the period. However, almost a quarter of companies did so, and in a minority of cases quite intensively.

In the limited space available here, attention will be focused firstly on summarizing the results of Wright and Coyne4 and secondly on a brief review of flotations of buy-outs. The results presented in the Hanney paper 12 generally support those presented by Wright and Coyne, and provide a valuable extension to that survey. The survey by Wright and Coyne drew its sample from data provided by funding institutions. The field-work for the survey was carried out in 1983 and 1984. Developments in the market-place since that date, particularly in the source and size of buyout as addressed earlier, may mean that the results of

Table 7. Two-way frequency distribution of acquisitions and management buy-outs by companies which have divested through management buy-outs (January 1984-June 1986) N u m b e r of acquisitions 0 1 2 3 4 5 6 7

1

2

1 63 8 6 6 2 2 1 -

12 4 3 3 1 2 . 2

N u m b e r of m a n a g e m e n t b u y - o u t s 3 4 5 3 1 1 2 . .

1 2 2 1 . . .

-

1 1 . .

.

.

7

No.

1 1 -

1 2 1

1

1

1 82 17 13 12 5 4 1 4 238

.

.

.

. -

Total 6

. -

% 76"5 7"1 5-5 5-0 2'1 1"7 0"4 1"7 100'0

Source. Derived from DTI M & A records and M B O records from the Centre for Management Buy-out Research, University of Nottingham.

44

Long R a n g e Planning Vol. 20

August 1987

the study understatc the performancc effects of buyouts.

The study addressed seven key performance areas of buy-outs (Table 8), covering employment, changes to product range, developments in trading relationships, effects on profitability, management changes, changes in trade union recognition, and the effects on cash flow. If the act of buying-out is seen to free management from the restrictions of parental control, adjustment may be expecte d so that the newly-independent entity can better meet the demands of its market-place. Given the various sources from which buy-outs arise, not all may be expected to require major adjustment. Indeed, if that were the case, prospective buy-outs may find difficulty in obtaining financial backing. However, major changes were observed in a significant proportion of the buy-outs. Most notably, 44 per cent were seen to shed labour at the time of the ownership transfer, particularly in those buy-outs from receivership. However, subsequent to this rationalization, buy-outs were on average net re-employers, with recruitment being carried out for real jobs in a financially sound enterprise. Substantial managerial changes were required in many buy-outs, mainly to adapt an inappropriate parentally imposed organization structure to one more suited to an independent existence in a particular market. Overwhelmingly, trading relationships between both customers and suppliers were seen to improve as control became more direct and the company was freed from problems caused by remote head offices. However, some buy-outs experienced cash flow difficulties as large trading partners attempted to take advantage of their independent and hence smaller status. 26 It was possible, though, for some buy-outs with cash flow problems due to the parent to be unable to resolve these issues on buy-outs. Surprisingly, perhaps, in view of some claims, buy-outs were little associated with removal of trade union recognition. Very often trade unions were seen as a necessary

communication channel which would otherwise havc to be invented. 27In case study follow-ups it was noticeable that attempts had been madc to bridge the 'US vs T H E M ' gap in enterprises in a direct way, thus developing channels of communication which did not necessarily involve trade unions. The results obtained from this survey were over the short-term, where many firms were still in a h o n e y m o o n period after the buy-out. Further research is currently underway to examine the longer term effects, particularly the issue of exit from the bought-out company by financial backers and the management. 24 The mode and timing of an exit are issues which need to be considered carefully at the time of the buy-out (Wright, Coyne and Mills, TM Chapter 9), though changing circumstances may significantly alter initial intentions. Exit may essentially take place in three ways--receivership, trade sale/acquisition, flotation. At present few statistics are available on buy-out failure through receivership. The market leaders 3i estimate that one in eight of all buy-outs that they have funded have failed. For their buy-outs where the initial transaction price was greater than £ 0 . 5 m , the failure rate is only 4 per cent.~ The success rate in buy-outs is, therefore, much greater than for completely new start-ups, as might be expected. However, apart from those buy-outs which have failed completely there are an u n k n o w n number of companies receiving careful attention and whose longer-term future remains highly uncertain. Buy-out trade sales can occur for reasons of either success or failure. In some cases trade sale may represent a higher and earlier return than can be envisaged from eventual flotation. Moreover, in smaller buy-outs it may offer the only realistic exit route, even if they are successful, simply because they may be too small to achieve a stock-market flotation. In some cases, trade sale may enable the

Table 8. Performance impact of buy-outs in summary Factor 1.

Employment

2. Product range 3. Trading relationships 4. Profitability 5. Management changes 6. Trade union recognition 7. Cash flow

Impact 44 per cent reduced employment on buy-out, by an average of 18 per cent. Post buyout companies were net re-employers, 11 '3 per cent on average Substantial introduction of new products post buy-out Customer and supplier relationships worse in only 2 per cent. Some attempt to reduce trading dependence on parents Improvements in over half of buy-outs At least one change in 41.4 per cent of buy-outs, especially changes to organization structure Loss of recognition in only 7 per cent of buy-outs No cash flow problems in 47 per cent of buy-outs. Many buy-outs removed previous cash flow problems, though new problems substituted for old

Source: M. Wright and J. Coyne, Management Buy-outs in British Industry, Croom-Helm, London (1985).

Management Buy-outs in Britain management team to obtain greater career enhancement, though in some instances it may be necessary where a split in the team has occurred. The largest relative gains to be recorded have been in General Computer Systems and Goodwin Barsby, both of which were sold for between eight and nine times their original buy-out price. The largest absolute gain was in the case of St. Regis which was sold for £ 7 4 m 8 months after it was bought-out from its U.S. parent for £ 3 2 m . The acquisition by the Burton Group of the John Collier buy-out, less than a year after its initial unsuccessful attempt at purchase, was achieved for a valuation corresponding to only 40 per cent of the buy-out price. The sale of Ansafone in 1986 to National Telephones for £ 2 . 2 m also represents a substantial decline in fortunes. Ansafone was one of the first large buy-outs, being acquired by management for £ 1 3 m in 1981.1s Prior to its sale, Ansafone had undergone several changes in senior management, including the removal of the original buy-out team, and substantial reorganization, being written down to a nominal value in the books of its financial backers. On the other hand Hornby, which was bought out from the receiver of D u n b e e - C o m b e x Marx went through a difficult position after buyout but recovered to be floated in late 1986. As the market-place develops, so an increasing number of flotations of management buy-outs have occurred. At the time of writing 102 had been traced. Flotations can be by Over-the-Counter, Unlisted Securities Market, or Full Stock-Market listing routes (Table 9). The O T C route tends to be a form of flotation used at the time of buy-out in some cases (see below). More usually the USM is preferred, because of size considerations, although with the narrowing of cost of listing differentials between markets and the increasing size of buyouts, companies are now just as likely to seek a full listing straight away. To date only one management buy-out flotation has involved a market capitalization of greater than £100m, that of Mecca Leisure in October 1986, although four others have achieved market capitaliTable 9. Stock Exchange listings of management buy-outs OTC

USM

Full

Total

1 980 1981 1982 1 983 1984 1985 1986 1987 (To end February)

1 1 1 2 1 -

1 2 4 7 6 21 22 2

2 1 2 6 6 13 1

1 5 6 10 14 27 36 3

Total

6

65

31

102

Source: Centre for Management Buy-out Research, University of

Nottingham.

45

zations of over £ 1 0 0 m in the period since flotation. O f those which have floated, the average time from buy-out to flotation is about 2 years--a figure which has been significantly influenced by the flotation of several companies in 1985 and 1986 within 1 year of buy-out. The average gain in valuation from flotation to the time of writing is 1.5, compared with 5.8 times between buy-out and flotation. This difference is due firstly to the effects of purchase at substantial discount on both value of assets and secondly to the relatively short time period over which companies have been listed. Alida Holdings, however, increased its market capitalization 4"5 times in the 2 years from flotation in November 1984. At the other extreme, Adam Leisure saw its market capitalization fall to one fifth of the flotation level.

V. Procedural Issues The procedural issues involved in conducting a management buy-out can be extremely complex, particularly in the more recent larger transactions. It is difficult to do justice to the issues involved in the short amount of space available here. At the risk of understating potential problems an attempt will be made to give the flavour of what is required. (i) Reference Material A number of sources of information are available to prospective divestors or acquirers. Large accounting firms involved in negotiating and advising on buyouts produce brochures briefly setting out some of the issues. The Economist Intelligence Uni& produces a report, n o w in its third edition, which covers in a relatively detailed but accessible way the issues involved and provides a list of the main funding institutions and their investment criteria. A lighter treatment is provided by Webb. 29 A more detailed practical guide, covering what is required, and highlighting possible pitfalls together with actual case study material is provided by Wright, Coyne and Mills. TM This book has an important section on life after buy-out which other sources tend to ignore. More technical details particularly on taxation issues and those involved in structuring the deal have been covered by the Institute of Chartered Accountants. 3° A comprehensive guide to the buy-out market-place, in 1985 covering details on all deals, 10 case studies, a list of all equity funders of buy-outs, detailed profiles of the major players and an analysis of syndication arrangements is provided by Coyne and Wright? (ii) Assessing Viability The essence of buy-outs is that management acquire a significant equity stake in their company which nearly always requires substantial amounts of outside equity and, more commonly, debt funding provided by one or more financial institutions. The deals are generally highly leveraged placing great

46

Long Range Planning Vol. 20

August 1987

emphasis on an ability to meet debt repayments from cash flow. For external funders to be interested in supporting the transaction, the newly independent enterprise must be perceived to be a viable entity. Viability may be judged from a company appraisal that institutions will require to be carried out and which covers the kind of topics shown in Table 10. These issues are seen to place emphasis on such matters as products and markets, production facilities, organization structures and manpower, existing financial resources and financial performance. Financing institutions which support management buy-outs are backing not just the trading performance of the company, but crucially the abilities of the core management team in making that business perform. As such it is necessary for backers to be convinced that a capable and cohesive team exists and which is strong in all key functional areas. In buy-outs on divestment it is possible that certain functions which will be vital when the company becomes independent are missing as they

Table 10. Example of topics to be covered in a company appraisal in the case of a buy-out from a parent company Topics 1. Company histories of subsidiary to be bought-out of parent 2. Markets and marketing the overall state of the market in which the subsidiary is operating the subsidiary's marketing policy the subsidiary's customers and suppliers seasonal trading characteristics 3. Performance (past and expected future) summary of past 5 years audited accounts profit forecast for first 3 years after buy-out cash flow forecast for first year after buy-out statement of assumptions on which forecasts based production and sales statistics for previous 5 years 4. Assets to be acquired fixed assets stocks and work in progress 5. Existing financial resources long-term capital structure and shareholders working capital (including detailed debtor and creditor position) taxation aspects 6. Manpower directors and their personal histories union representation workforce size and characteristics (including charges) key employees and management and their effectiveness 7. Organization of the company organization chart how the company is managed and controlled how effective is the current management and control of the company state of industrial relations Source." M. Wright, d. Coyne and A. Mills, Spicer and Pegler's Management Buy-outs, Woodhead-Faulkner, Cambridge (1987) (adapted).

are carried out at group level and these gaps will therefore need to be filled. In larger buy-outs it may be necessary to bring second tier management into equity participation in order to ensure stability and to extend the necessary level of motivation d o w n the managerial hierarchy. The price to be paid for the buy-out has an overriding influence on the viability of the deal. Price determines the amount of funding to be raised, and it is necessary to ensure that th~ underlying profit and cash stream will be sufficient to service the finance package. In some cases surplus assets may be available to be sold shortly after buy-out so as to bring external funding d o w n to more manageable levels or alternatively current performance may significantly understate future levels where the beneficial effects of investment and rationalization programmes have not yet worked through. Whatever happens a realistic price must be paid for the business, otherwise management may be saddled with a funding level which cannot be serviced. It is better not to buy-out than to plunge oneself into such a position. (iii) Role of Advisers It is in negotiating the appropriate price and in several other important areas that an independent adviser can provide management with a great deal of help. Independent advisers can provide buffers between the management team, and the vendor and funding institutions. This role is crucial because of the complexity of negotiations and the consequences if things go wrong. The complexity of negotiations is illustrated by the myriad of actors

Table 11. Negotiations--the actors Vendor's party Vendor Auditor/financial adviser Solicitor Consulting actuary/pension adviser Property consultant Tax adviser Stockbroker Purchaser's party Buy-out team Personal financiers for the team Financial adviser/negotiator Solicitor Consulting actuary/pension adviser Property consultant Tax adviser Financier's party Lead financial institution Syndicate financiers Solicitors to financing syndicate Investigating accountants Clearing banker Leasing/finance company Source." M. Wright, J. Coyne, A. Mills, Spicer and Pegler's Management Buy-outs, Woodhead-Faulkner, Cambridge (1987).

Management Buy-outs in Britain

47

(iv) Finance In 1981 it was difficult to find any financing institution listed in the usual reference sources which claimed an interest in supporting buy-outs. Five years later it is difficult to find an institution which does not claim to support buy-outs. However, not all of these actively fund buy-outs, and amongst the 100 or more institutions that do, experience and expertise varies widely. In 1986 3i was involved in the funding of 97 management buy-outs. Excluding direct activity by local branches of the Big 5 clearing banks only seven other institutions in 1985 funded more than 10 buy-outs and at the other extreme, 48 institutions participated in only one buy-out each?

who may well be involved in a typical management buy-out changing hands for upwards o f £ 5 m using syndicated finance (Table 11). Negotiations involve not only the price to be paid, but other crucial areas such as obtaining the most tax efficient structure and agreeing the fair transfer value of pension rights. It is not really possible for management alone to deal with these issues and continue to run the business in the meantime. Sensitivity in negotiations occurs as the existing employer-employee relationship is changed forever, even with apparently very willing sellers. If negotiaions are unable to proceed to the satisfactory conclusion of a deal, it may be tactically appropriate to 'blame' the adviser, 'sack' him and strive to restore normal employer-employee relations. H o w e v e r it is extremely important at the outset for management not to compromise its position. In order that directors do not breach their legal duties and responsibilities it is essential that written clearance is obtained from the vendor to disclose to a third party commercial information relating to the business. It is a good practical idea to carry out all activities relating to the buy-out away from company premises, in the team's own time and at its o w n expense. It is by no means u n k n o w n for management teams to be summarily fired for not adhering to these rules. The actual carrying of cloaks and daggers is, of course, optional!

The institutions supporting buy-outs are of several different types, and each may express a preference for a particular type of funding (Table 12). Equity capital refers to straightforward ordinary shares, whilst quasi-equity involves capital which typically carries both the right to a reasonable running yield to the provider and the option to convert into straight equity. Such shares often carry a dividend entitlement element directly related to the performance of the buy-out. Debt finance may be either secured or unsecured and redeemable preference shares may be viewed as an alternative to loan stock since repayment of the funds invested in the business may be obtained. Leasing/HP/factoring funds provide alternative sources of funding. Deferred payment may be obtained from the vendor either in the form of loans (either interest bearing or not) or in the form of an equity stake. The particular combination of these funds depends upon the type of buyo u t - - s o m e may be all equity, some all debt finance, but most contain a mixture of funding types. Differing institutions have different risk-return preferences, so that the ratio of each type (gearing ratio) will vary. For larger deals it is usual for more than one institution to participate in the funding. Such syndication can take one of the three general forms as shown in Table 13. Vertical slicing involves the establishment of an overall structure for the transaction, with each participating institution obtaining an amount of each type of finance pro rata to the amount of funds contributed. Horizontal slicing obtains where participating institutions con-

The other side of the role of advisers is in finding the best financial package for a management team. Different buy-outs require different packages and financing institutions tend to have particular house styles. Moreover, financing institutions fund buyouts for the return it brings to them and hence have their o w n interests to protect. It is only the adviser w h o is being paid to look after the interests of the managers. However, care is needed in choosing an adviser who is genuinely objective and with w h o m the management team feel comfortable. Institutions do vary widely in the package they would propose for a given case. It is by no means u n k n o w n for one institution to offer an equity split of say 80 per cent to 20 per cent in its favour whilst another institution would be prepared to offer precisely the reverse. Table 12. Matrix of fund types and sources

Clearing banks ( i n c . V e n t u r e a r m ) Merchant b a n k s Captive institutional investors Independent investment companies Foreign i n s t i t u t i o n s Business expansion s c h e m e Over-the-counter markets P u b l i c sector bodies Former parent/owner Individual Specialist b u y - o u t f u n d

Equity

Quasi-equity

Debt/redeemable prefs

x x

x x

x x

keasing/HP/

factoring x

x

x

x

x

x

x

x

x

×

x

x

x

x

x

x

x x

x

x x

x x

Deferred payment

x x

x

x

48

Long Range Planning Vol. 20

August 1987

Table 13. Typical structures of syndicated deals Vertical slicing Investor Ordinary shares CCRPOs Preference shares Loan stock

A 25 70 100 600

B 15 50 70 70

C 15 50 70 70

Total

795

205

205

A 55

B

C

Horizontal slicing Investor Ordinary shares Preference shares Sub. loan stock Loan stock Total Complex Investor Ordinary shares CCR POs Preference shares Sub. loan stock Loan stock

D

D

E

E

F

F

Mgmnt 65

65

1270

Mgmnt 65

Total 120 220 150 780

220 150 780 55

220

150

780

A 10 100 100

B 20 50

C 15

D 10

E

F

65

1270

Mgmnt 65

Total 120 150 175 150 675

75 150

200 410

475 70

90

10

150

475

Total 120 170 240 740

65

1270

Note. CCRPO is cumulative convertible redeemable preferred ordinary share. All amounts in £'000. Source: J. Coyne and M. Wright, Review of U K Management Buy-outs in 1985, Venture Economics, London and Centre for Management Buy-out Research, University of Nottingham (1986).

tribute one particular type of financing. In complex structures participating institutions may take different combinations of the various types of finance involved. In these syndicated arrangements it is c o m m o n to have one or more syndicate leaders who will set the basic structure of the deal and seek second tier funding from various other institutions. Syndicate leaders may take an extra equity 'sweetener' or subscribe on more favourable terms as the price for putting the package together. It is increasingly c o m m o n for financing structures to contain ratchets, whereby the management team's equity stake can vary according to achievement of pre-set performance criteria, relating to profit levcls, cash flow levels or the meeting of target dates for flotation or trade sale. In some cases the ratchet may enable management's equity stake to rise substantially from a low level (the 'carrot' route) or for management's share to rise according to performance (the 'stick' route). Some may have a combination of both! All financiers expect an exit sooner or later and will include provision in the financial package for the removal of the team if performance is unsatisfactory.

VI. Conclusions The purpose o f this paper has been to present a broad overview of management buy-outs in the United Kingdom. In the 1980s the phenomenon has developed rapidly, particularly in 1985 and 1986, and has n o w become an important and natural part of corporate strategy. Such a position presents both

threats as well as opportunities to parental management. For example, parents may need to consider carefully action to prevent incumbent subsidiary management from making pre-emptive strikes. For managers attempting to buy-out, increased awareness by parents and the re-emergence of potential trade acquirers may increase prices such as to place a viable deal out of reach. The continued high level of activity and wide variety of buy-outs being completed does, however, demonstrate the continued existence of fundable deals. The parallel development of the financial market which is prepared to support buy-outs has, of course, made it possible to complete transactions which were unthinkable 5 years ago. But as the previous section has outlined, there remain many difficult procedural hurdles to be negotiated before a buy-out can be completed. Overall, management buy-outs have become and will continue to be an important element of the corporate strategic scene. Retiring shareholders and restructuring groups will continue to see a place for management buy-outs. Moreover, there probably remains a substantial number of firms who have yet to embrace the buy-out as a practical option. This paper should contribute to a greater awareness on their part of the possibilities afforded by management buy-outs.

Refet'ences (1) J. Coyne and M. Wright, Review of UK management buyouts in 1985, Venture Economics, London (1986).

Management Buy-outs in Britain (2) S. McLachlan, The NFC Staff Buy-out, Macmillan, London (1983). (:3i I~. (Jakeshott, The employee buy-out at NI~C, Public Money, 15-18, December (1983).

49

(29) I. Webb, Management Buy-out, Gower, London (1985). (30) J. P. Hardman and M. R. Young, Management buy-outs, Accountants Digest No. 133, Spring (1983).

(4) M. Wright and J. Coyne, Management Buy-outs in British Industry, Croom-Helm, London (1985). (5) C. Mulley and M. Wright, Buy-outs and the privatisation of National Bus, Fiscal Studies, 1-24, August (1986). (6) R. J. Maupin, C. Bidwell and A. Ortegren, An empirical investigation of publicly quoted companies which change to management buy-outs, J. Bus. Fin. Acc. 11,435-450 (1984). (7) J. Taylor, Going private, Financial Executive, 30-41, April (1984).

Further reading R. V. Arnfield, B. Chiplin, M. Wright and M. Jarrett, Management Buyouts." Corporate Trendfor the 198087, Nottingham University, IBLO (1981 ).

(8) H. DeAngelo, L. Angelo and E. Rice, Going private: minority freeze-outs and stockholder wealth, Journal of Law and Economics, XXVII, 367-402 (1984).

K. Arrow, The Limits of Organisation, Norton, New York (1974).

(9) M. C. Jensen, Agency costs of free cash flow, corporate finance and takeovers, American Economic Review Papers and Proceedings, 323-329, May (1986).

R. Butler and M. G. Carney, Managing markets: implications for the make-buy decision, Journal of Management Studies, 20, 213-231 (1983).

(10) L. Lowenstein, Management buy-outs, Columbia Law Review, November (1985).

B. Chiplin and M. Wright, Divestment and structural change in U.K. industry, National Westminster Bank Review, 42-51, February (1980).

(11) H. DeAngelo, Management buy-outs of public stockholders, Accounting Review, July (1986). (12) J. Hanney, The management buy-out---an offer you can't refuse, Omega, 14 (1986). (13) M. Wright and R. S. Thompson, Debt finance, agency costs and management buy-outs, Centre for Management Buy-out Research, Occ. Paper No. 2 (1986). (14) M. Wright, J. Coyne and A. Mills, Spicer and Pegler's Management Buy-outs, Woodhead-Faulkner, Cambridge (1987). (15) J. Coyne and M. Wright, Buy-outs and British Industry, Lloyds Bank Review, 15-31, October (1982). (16) S. Birley, Success and failure in management buy-outs, Long Range Planning, 17, 32-40 (1984). (17) J. Coyne and M. Wright, Divestment and Strategic Change, Philip Allan, Oxford (1986). (18) J. Coyne and M. Wright, Buy-outs and corporate strategy, in International Management Development Review, Management Centre Europe, Brussels (1986). (19) M. Wright, Divestment and organisational adaptation, European Management Journal, 3, 85-93 (1985). (20) M. Wright, Demergers, in J. Coyne and M. Wright (Eds), Divestment and Strategic Change, Philip Allan, Oxford (1980). (21) M. Wright, The make-buy decision and managing markets: the case of management buy - outs, Journal of Management Studies, 23, 443-464 (1986). (22) M. Wright, B. Chiplin and J. Coyne, The market for corporate control: the divestment option, in J. A. Kay and J. Fairburn (Eds), Mergers and Merger Policy, IFS/OUP, London (1987).

B. Chiplin and M Wright, Management buy-outs--a lifeline for industry, Accountancy, 64-67, December (1981 ). B. Chiplin and M. Wright, The Logic of Mergers, Hobart Paper No. 107, Institute of Economic Affairs, London (1987). A. C. Cooper, Spin-offs and technical entrepreneurship, IEEE Transactions on Engineering and Management, EM18 (1971 ). J. Coyne, Management buy-outs: variant and variety, in J. Coyne and M. Wright, Divestment and Strategic Change, Philip Allan, Oxford (1986). J. Coyne and M. Wright, Management buy-outs, Omega, 417-419 (1986). T. C. Cooke, Mergers and Acquisitions, Basil Blackwell, Oxford (1986). I. M. Duhaime and J. H. Grant, Factors influencing divestment decision-making: evidence from a field study, Strategic Management Journal, 5, 301-318 (1984). M. Ezzamel, On the assessment of the performance effects of multidivisional structures--a synthesis, Accounting and Business Research, 23-34, Winter (1985). R. H. Frank, Are workers paid their marginal products?, American Economic Review, 74, 549-571, September (1984). D. A. Garvin, Spin-offs and the new firm formation process, California Management Review, XXV, January (1983). C. W. L. Hill, Internal organisation and enterprise performance: some evidence, ManagerialandDecision Economics, 6, 210-216 (1985).

C. S. Jones, An empirical study of the role of management accounting systems following takeover or merger, Accounting Organisations and Society, 10, 177-200 (1985).

(23) M. Wright and R. S. Thompson, Divestment and the control of divisionalized firms, Accounting and Business Research (forthcoming, Autumn 1987).

S. Sabin, At Nuclepore they don't work for GE anymore, Fortune, 144-153, December (1973).

(24) M. Wright, K. Robbie and J. Coyne, Management Buy-out Flotations, Spicer and Pegler Assoc./Centre for Management Buy-out Research (1987).

F. M. Scherer, Mergers, sell-offs and managerial behaviour, paper presented to the 1 lth EARLE Conference, Fontainebleau, August (1984).

(25) S. Green, The meaning of ownership in management buy-outs, London Business School, Working Paper No. 05 (1986),

N. Wallner, The Leveraged Buy-out Manual, La Jolla, California (198O).

(26) J. Coyne and M. Wright, Buy-outs cash flow: the reality after the honeymoon, Accountancy, 154-156, April (1984).

O. E. Williamson, Markets and Hierarchies, The Free Press, New York (1975).

(27) M. Wright, J. Coyne and H. Lockley, Management buy-outs and trade unions: dispelling the myths, Industrial Relations Journal 15, 45-52 (1984).

M. Wright and R. S. Thompson, Vertical disintegration and the life cycle of industries and firms, Managerial and Decision Economics, 7, 141-144 (1986).

(28) Economist Intelligence Unit, Management Buy-outs, EIU Special Report, 3rd edn (1986).

M. Wright and M. Jarrett, New financing initiatives in smaller companies, Nat West Bank Review, 40-52, August (1982).