Buy-Outs: Capital still ready for a little venture: There is still money available for management which decides to take the step to ownership

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The Independent Online
Reports of the demise of the management buy-out market have been exaggerated. The highly-leveraged mega-deals of the 1980s, such as the buy-outs of the furniture groups MFI and Magnet, may be a thing of the past, but activity has hardly wavered among small and medium-size companies.

Low prices, coupled with renewed interest from banks and equity providers, make prospects brighter than ever for managers contemplating the move.

Because investors are more cautious and willing to back only well-managed, sensibly funded deals, the buy-outs that go ahead are more likely to succeed than those launched even three years ago.

The most fertile source of MBOs at the moment is not fire sales: most companies have already battened down the hatches. But many others are in survival mode, concentrating on their core activities, which may entail starving peripheral businesses of cash. 'Many managers have decided to do the group and the subsidiary a favour and buy themselves out,' says Ian Hawkins, senior partner of Phildrew Ventures.

A popular misconception about MBOs is that to raise big money you have to put up big money. But while some individuals do raise pounds 50m, ' pounds 10,000 can represent absolute commitment,' according to Eric Walters, a partner in Schroder Ventures. Managers must demonstrate their commitment up front, but, says Mr Walters: 'We don't want them sweating about it first thing every morning when they wake up, or having to pull their children out of school or sell their caravan.

'What's important,' he says, is that people are 'driven'. 'We want people with a real bee in their bonnet. Not just to buy the business, but to really do something with it and show how good they are.

'Most buy-outs arise out of sheer frustration.'

As a rule, venture capitalists back teams, not individuals. The team must be a meld of entrepreneurial drive and solid management. A finance director gives comfort, but lack of one would not scupper the deal. The venture capitalist will recruit one if necessary. 'Last time I put an ad in the Financial Times for a finance director, I was inundated with replies,' says Mr Walters.

Phildrew has just launched its third buy-out fund, worth pounds 108m. Its average investment is pounds 3m and rising, but preferred deal size varies between venture capitalists. Schroder Ventures, for example, which still has pounds 75m from its second MBO fund of pounds 168m to invest, will typically inject about pounds 1m of funding per deal. 3i's average investment is pounds 500,000.

But backers exercise caution on both deals' funding - the ratio of debt to equity has fallen from about 4:1 three years ago to 1:1 - and their nature. The banks are keen that interest is repaid, and the equity providers - who typically look to realise their investments within three to five years through a trade sale or a flotation - want to ensure the business is capable of growth.

A good market and trading position, strong management, reliable accounting and healthy cash flow are crucial, and companies with assets provide additional comfort. Buy-outs from receivers do happen but are treated with caution. 'We feel it's often tarnished goods. The management may have helped the company get into trouble in the first place,' Mr Walters says. Backing management buy- ins into such companies is even more risky, as the new managers will have only limited knowledge of the business.

'What we're after,' says Mr Hawkins of Phildrew, 'are established businesses which are large enough to support professional management, but not so large that they can't be managed or grown.'

Phildrew has had significant exposures to furniture and carpets in its first and second funds, and would like to improve its spread. Natural resources and property are out of bounds for most backers, but everything else is fair game. Industries which are ostensibly least attractive often yield the best results. 3i is particularly interested in the manufacturing sector at the moment because it is at the bottom of the cycle and is asset-backed.

A combination of track- record and energy is crucial to cope with the vicissitudes of business life. Sufficient confidence to establish credibility in the marketplace is also important. But even prospective buy- out teams which meet all these criteria may not succeed. Only about one in every hundred deals put to venture capitalists is realised. The rest fall for a variety of reasons: the buy-out team's bid may lose; it may get cold feet; or the venture capitalist may reconsider after further investigation.

Those who fail to master their market will be the first to be shown the door. The business plan is also crucial in making a first impression. Ten sheets of A4 containing details of competition, markets, history, products and projections, will invariably go down better than 100 glossy pages.

Lying, even by omission, is another recipe for rejection. 'Like the guy who failed to tell us he'd gone bust in the past,' says Mr Walters. 'Going bust in itself was not a problem: 'forgetting' to mention it was.'

Schroders follow up references meticulously, so it is most unlikely that a detail such as bankruptcy will escape their notice. Each individual has to provide six references - two personal and four business.

Mr Walters is surprised by the number of applications citing Aunty May or the family solicitor as referees. Ideally you should include a couple of ex-bosses, a couple of people you have worked with on a similar level, and a couple of subordinates. And the references need to be balanced. Nothing arouses more suspicion than reports of unalloyed excellence.

'We're professional cynics,' says Mr Walters. 'If someone came out as whiter than white we would just take out more references.'

Smoothies don't make good buy-out managers, says Mr Walters. 'We want people who have rubbed people up the wrong way. We want doers, not politicians.'

(Photograph omitted)

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