Management buyouts have evolved over 40 years, and as transactions have increased in size institutional investors have concentrated more on due diligence, the venture capital term applied to the checks carried out prior to committing to an investment.
Due diligence is usually centered on two areas; strong management team and a positive cash flow.
Of the two, the ability of the management team is seen as the most important. However good the cash flow, whatever the potential of the product or technology, neither will be exploited successfully without a capable and complete management team.
Venture fund managers expect to be strong in every function: marketing and sales, the use of new [url=https://www.bestmoneymakingtips.com]internet marketing tools[/url], production, finance. And most important of all is the managing director, capable of leading his troops from the front.
Most fund managers will say that the non-executive directors have a key role to play too. To be effective they must be acceptable to both management and institutions, and they must be able to make a contribution to the business.
At Murray Johnstone, where the Glasgow fund manager has had particular success in the management buyout field, a register is kept of more than 50 individuals with excellent track records.
Most investing institutions insist, first and foremost, an absolute trust in the people running the business which they are being asked to help finance.
Second, the fund manager will look for a strong and positive cash flow. Most such transactions today are highly geared, with the debt having not only to be serviced but also repaid.
High gearing on the one hand increases the risk and on the other the potential rewards to both management and investing institutions. Responsible institutions satisfy themselves that the level of debt will not jeopardize the future of the company.
Positive cash flow emanates from three main sources; profits, the disposal of unwanted assets and the tighter control of working capital. Investors will want to see a profit base secured by a mature product which can at least maintain its market share in the medium term. Under-utilized assets which can be realized have obvious advantages, but it is also important to ensure that the company is able to invest sufficient funds to at least maintain its competitive situation.
High technology businesses with significant R & D expenditure, and companies with large capital expenditure programs often start at a disadvantage, however in such cases, buyouts can be structured, but the element of gearing must be carefully controlled.
Whatever the circumstances, responsible institutional investors are wary of cyclical companies. A recession with a downturn in both activity and margins, coupled with an increase in interest rates, can be a lethal cocktail if gearing is material.
Institutions also place some importance on the financial commitment of the management team. Management is responsible for the success of the company, and will invest on more favorable terms than the institutions.
However, this carried interest should be reasonable, and most institutions prefer that capital rewards are linked to performance in some way.
Management's financial commitment should be material, but not to the extent that its members spend more time worrying about their personal position than the company's cash flow.
Buyout failures arise when a management team is not strong enough to run the business so that the debt can be serviced and repaid.
Responsible institutions recognize these potential problems and avoid the more risky situations. In a large portfolio it is inevitable that there will be companies which do not perform to plan, and in some cases lead investors take an active role at an early stage to ensure that any weaknesses can be corrected.
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