A management Buyout (MBO) is a highly leveraged purchase of a business.
What this means is that a management team is buying the business using borrowed
money and as a result the new company (newco) has a great deal of debt. The
result of this is that it is essential to manage cashflow very closely until
that debt is repaid. At this stage we could talk about measuring and setting
debt covenants as a reason for the model but it is much more simple and
fundamental than that. The model helps you manage cash and therefore not do
what businesses with no cash do. This gives us reason one for the financial
model.
REASON ONE - MANAGE CASHFLOW IN A HIGHLY LEVERAGED VEHICLE (AKA DON’T GO
BUST)
The investors lending the money are financial institutions who report to
shareholders and investors. They have promised those shareholders and investors
a certain return and they invest based on a business forecasting those returns.
Depending upon the funder you are going to they will use different measures
like Internal Rate of Return (IRR) or even a simple multiple of cash, in any
event this gives us reason two.
REASON TWO - MEASURE THE EXPECTED RETURN FOR INVESTORS (AKA VALUE THE
BUSINESS)
The reason that the model is called a fully integrated financial model
is that it should be complex enough for you to be able to sensitize it. What I
mean by this is that whatever the risks or variables are in your business be it
losing a specific contract or in an FMCG business maybe a downturn if 5% in
turnover, the model should, at a stroke of a key, be able to recalculate this.
This will mean that the operating aspect of the model (this part that relates
to the business rather that the financing) should be bespoke for each business.
I am only one man, however, my belief is that “standard” operating models, by
this I mean ones where you essentially fill in field on your business and then
it spits out a “standard” model are not as effective as a real bespoke model.
In any event, if you have appointed a proper Lead advisory firm their fees will
likely run into six figures and likely multiples of that. They should have the
skills in-house to write a bespoke operating model.
Once you run these sensitivities the model should give new returns
information. A good model should, as a minimum, give IRR for each equity funder
as well as Mezzanine debt provider in a matrix format so that at one glance you
can see the suit of potential returns based on exit multiple (the driver of
price), exit year (when you sell the business), purchase price and management
equity stake (HOW MUCH YOU GET). These will be used throughout the process and
most essentially in two parts.
1.
When approaching funders and deciding who
to work with (partly based on price and equity stake)
2.
When digesting the feedback from Due Diligence
investigations (with an obvious effect on price and equity stake.)
So you can see that the model can be used to demonstrate arguments about
why your equity stake should be higher or lower at key stages of the
transaction. So let me ask you this question: Who do you think will have the
best understanding of the financial model? The team who wrote it? So who do you
want to write it and control it? Your advisor? Someone else?
