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Last Updated: Friday, 28 January, 2005, 08:26 GMT
The management buy-out minefield
By Will Smale
BBC News business reporter

Hollywood actor George Clooney
Mr Clooney would not confirm if he will play the lead in MBO II
Management buy-outs are one sector of business life that could make a particularly good movie.

After all, in many cases they include the drama of tough and tense negotiations, the stress of trying to raise a great deal of money, and a nerve-wracking race to meet a seemingly unachievable deadline.

Add a philanthropic desire to save a long established business and the livelihoods of its loyal staff, and all you'd need is a good scriptwriter. And maybe some added love interest.

But firmly back in the real world, management buy-outs (MBOs) are a daily occurrence in the UK.

According to figures from the Centre for Management Buy-Out Research at Nottingham University Business School, 314 MBOs were completed in the first half of 2004 - the equivalent of 12 a week - at a total value of 7.6bn.

But exactly how do MBOs take place, and what are the potential pitfalls both during the process and after one has been successful?

Main opportunities

"Typically there are two scenarios," says John Cole, a management buyout specialist at Ernst & Young.

Some MBO teams are staggered by the level of questioning and detailing
John Cole, Ernst & Young

"Number one is when a corporation wishes to divest a certain manufacturing plant or other facility, and the second is when the owner of a small or medium-sized firm wants out."

In both cases the management team running either the facility or company in question can consider going forward with an MBO to take over the business.

ClarityBlue is one such firm that was founded by an MBO.

A hi-tech company, its software systems allow a number of blue chip firms - from Lloyds TSB to Vodafone - to monitor and develop their interactions with their customers.

Before its successful MBO in 1993, it was part of a US company, but today it is wholly UK owned.

"Basically it got to the stage where we outgrew our American parent company," says ClarityBlue chief executive Duncan Painter.

"We were by then representing 80% of the business, and it became obvious that it was no longer sensible for them to keep control of us. We needed a lot more investment than was possible to continue to grow and develop."

Market pressures

With ClarityBlue's then parent prepared to let the business go, Mr Painter and his fellow directors immediately faced one of the first hurdles that can scupper even the best potential MBO - tough competition. No fewer than three outside companies expressed an interest in buying the firm.

Hollywood actress Renee Zellweger
Ms Zellweger could play a hard-hitting venture capitalist

With sentiment being a very low business priority, the US parent firm simply choosing Mr Painter's team out of loyalty was out of the question.

"Our proposal had to be competitive, the best possible," says Mr Painter. "We had to pay a fair price."

"In the end I think the company went with us - both because we offered a very good financial deal, but also because we would continue to be one of their main customers. That was the balance they decided to take."

Raising money

Once a management team has its first inclination that an MBO might be possible, its next thoughts will turn to trying to raise the finance.

This can include going to its bank manager, but in many cases, it will need to turn to a venture capitalist or private equity firm to raise the funds it requires.

In simple terms, the two types of firm perform a similar role. They work by lending the MBO the cash it needs and by taking a stake in the MBO company for a return of typically between 25% to 30% on their investment over three to five years.

It would be madness to exaggerate in your business plan, as this will immediately backfire as soon as you start to fail to hit your targets
Duncan Painter, ClarityBlue

And if you think your bank manager can be a tough operator, you have never met a venture capitalist. These people do not so much "not suffer fools gladly", as attack them before throwing them out of their office.

To avoid any such embarrassment, an MBO team needs to have a business plan more watertight than a nuclear submarine.

Vital accuracy

"Some MBO teams are staggered by the level of questioning and detailing," says Mr Cole.

"A venture capitalist will want to know absolutely everything."

"Do not exaggerate" is the simple advice of Mr Painter.

Suddenly the managers have to immediately learn a whole range of new skills
John Cole, Ernst & Young
"We were extremely honest with our private equity firm about our business plan and where any potential problems could be," he says. "We wanted them to come in with their eyes fully open.

"It would be madness to exaggerate though, as this will immediately backfire as soon as you start to fail to hit your targets. Then you would be in trouble."

New pressures

Thankfully for Mr Painter, ClarityBlue continues to be a success. He says it expanded by 35% in its first year and he is targeting 55% for the second.

Yet while ClarityBlue is now firmly established, other successful MBOs can go on to fail for a number of reasons, as Mr Cole explains.

"Suddenly the managers have to immediately learn a whole range of new skills, particularly if they have bought out from a large company.

"They may be excellent at managing what their company produces or supplies, but suddenly they have to also do everything that before they took for granted, such as looking after the IT infrastructure, human resources, payroll etcetera."

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