Management buy-outs: The easy way out?

The potential pitfalls and problems with management buy-outs

A management buy-out might be seen as an easy exit or a fast track to ownership. However, Jacqui Withnell found that there was plenty to contend with before her team was able to seal the deal for Nethercoats

Halifax-based interior structure manufacturing business Nethercoats is a family-founded firm. It has passed through two generations of ownership, has several long-term staff and enjoys close ties with its sector. However, when its joint managing director, Paul Nethercoat, needed to retire, he wanted to hand over the reins to someone who would preserve the company’s prestige. The business required a professional team that could take it forward into the 21st century. Co-managing director Jon Stanger called in Jacqui Withnell, a business associate he had worked with for several years. Her first mission was to guide the business through a management buy-out (MBO) and enable Nethercoat to exit fully. Withnell was impressed by the company’s product and reputation, and felt this was a serious business opportunity. However, MBOs are often emotional affairs, with technical pitfalls that can catch out the uninitiated. While the MBO was an eventual success, it was no stroll in the park.


Before completion, there was a tough due diligence process, a funding search and difficulties over valuation. Meanwhile, Withnell was a newcomer to the business and a female in a male-dominated industry. “A lot of the managers felt they should have been invited to be shareholders, so there was quite a lot of animosity,” she recalls. “You’ve got to be a certain character to do it. It’s almost like buying an old house and having a vision of how it will look once it has been refurbished.” Withnell joined the company as operations director in July 2008, and wisely set about a due diligence process before moving ahead with the sale. When she looked at the accounts, she felt they didn’t provide an accurate picture of the business, so she brought in Helen Thain, a consultant financial director. Thain’s audit found that work in progress was greatly overstated, leading to inflated profits in previous years. This resulted from long-term contracts being accounted for incorrectly. Profits were being taken without factoring in all the costs and before the projects were complete. Withnell says this threw the whole valuation of the business into doubt, since it reduced the company’s profitability on paper and, combined with the multiple, this led to a sharp drop in the sale price. “Don’t take everything at face value just because you have a set of accounts,” she warns. “Once you know where you are with the financials, there’s a period of negotiation with the seller. That can be a deal breaker and nearly was in our case.”   An independent consultant was brought in to look at the differences between the two sets of accounts and decide which valuation was the correct one. Fortunately, the consultant verified Thain’s findings and a figure was agreed for the business. However, there was first a period of uncertainty and the deal could have fallen through while discrepancies regarding the sale price were ironed out. For those considering an MBO, the message is clear: if you don’t do a thorough job investigating the business, you risk getting burned. But if you do, you might unearth a few surprises.

Funding Chase

Initially, Withnell looked at getting grant funding, which for a manufacturing business in the North is often a viable strategy. However, they fell foul of a postcode lottery. Halifax has a huge employer in the form of HBOS, which affects its status for grants. Had the business been in any of the adjoining areas, the door would’ve been open. Venture capitalists (VCs) were approached next, but they wanted to parachute board members in and had projections at which the team baulked. MBO teams are nearly always required to put up personal guarantees when working with VCs. They will also often be asked to offer preferential shares to their investors, enabling them to exit first or flood the company with shares if the money isn’t available. Withnell and her team then went to the banks, which “laughed in their faces”. However, they did eventually find a sympathetic ear at NatWest. The work Thain had done on the management accounts had raised the company’s prestige in the eyes of lenders. Withnell then replaced the company’s solicitors and accountants with a more suitable team, and a deal was struck. The MBO took place in January 2009, and Withnell became its joint managing director alongside Stanger. It had been a tough six-month slog and, of course, this was just the beginning.

New Start

The new management team is already making its presence felt, and training is being organised for all staff. The company is also improving its manufacturing  standards and business processes, and hoping to take advantage of the weak pound by exporting more. Meanwhile, Withnell says she never took any of the initial resistance to her arrival personally. So with the deal behind her, what advice does she offer other MBO teams? “Engage as good a professional services team as you can afford,” she replies, “and do your due diligence thoroughly, as it will save money in the long term. There is a lot of work to do on top of your day job, so share the workload between the MBO team. You also need to believe it will happen, as there are many hurdles along the way. Finally, enjoy the journey.”

Can they really manage?
Yavan Brar is a lawyer at Herrington Carmichael and has advised on numerous management buy-outs. He puts success down to the quality of the team involved

“Management buy-outs (MBOs) are a very useful exit route for many companies, but the devil is in the detail. In my experience, entrepreneurs don’t develop strong management teams, just good administrators and sales forces. “The entrepreneurs I have met, on the whole, do not share decision making, but they leave the detail to their administrators, and that can be the big problem. “Just calling someone ‘management’ does not make them a good manager. “Once an entrepreneur makes the decision, he needs to prepare his team and provide motivation, usually by involving them in the negotiation process early on. “I saw one prospective MBO team so unprepared that, when the bank was brought into meet them, the individual members had no idea of the process and the mechanics. Needless to say, the deal did not get off the ground.”


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