A forced sale is a special situation. The vendor has a weak negotiating positing and is seeking cash simply to survive. In any other circumstances the decision to sell will result from the relatively poor returns being produced by the company in question, its lack of fit with other 'core’ group companies, or both. It is not immediately obvious why a management buyout should solve the problem of poor returns. If capital starvation has been the problem historically, it is unlikely to change much in the leveraged situation which the buyout will create. A corporate buyer might, on the other hand, have the resources necessary to improve performance.
If capital starvation is not the cause of the company's poor returns, then one wonders why its existing management team is best qualified to put things right. Of course, a buyout might just be the answer if the price at which the vendor sells the company is sufficiently low. But it would have to be low enough to offer the buyout equity investors the prospect of 30+ per cent rates of return and then the question is why the vendor (who, after all, knows the company better than anyone else) should let it go at that price. This leaves the other possibility, namely a disposal for reasons relating to broader corporate strategy.
Corporate finance is essentially a fashion industry. So disposals of profitable businesses for strategic reasons are also very common. But this can be even trickier to assess. The virtues of a focused 'core' business approach may later become discredited in favour of a diversified portfolio strategy. And even the definition of core business may be retouched so as to provide, say, for 'good management' as the core business in the case of a persistently successful conglomerate. Whatever the fashion, its followers generally seek to demonstrate that it will enhance shareholder wealth, and over the last 25 years or so both varieties have enjoyed extended spells of popularity.
Today the core business approach holds sway and 'unbundling' is the accepted way forward. Yet presumably the corporate financiers produced a no less telling rationale for the companies involved to 'bundle' in the first place. So if a company which is performing well is to be sold for strategic reasons, one would expect the price fully to reflect its potential value. Can a buyout compete? A management buyout can offer no synergies. The benefits of combining are absent if there is nothing to combine with. So the buyout is justified only if, taking into account the price to be paid and the benefit from gearing, the future profits and cash flow from the company, including its resale value - of which more later - are expected to produce an appropriate financial return to the buyer.
To support the case for a buyout, an enormous amount of analysis will normally be carried out, with the management of the target company typically centrally involved. This 'due diligence' process seeks to leave very little to chance and literally all of the available facts will be carefully assessed, together with likely movements in the variables believed to govern future performance. If this extensive analysis gives the buyout financier sufficient comfort, he will then offer that price which, after allowing for a healthy debt component in the consideration, remises an internal rate of return of, say, 35 per cent a year. Yet frequently and significantly more. And usually, he will have been denied the benefit of having the management's own detailed plans.
If capital starvation is not the cause of the company's poor returns, then one wonders why its existing management team is best qualified to put things right. Of course, a buyout might just be the answer if the price at which the vendor sells the company is sufficiently low. But it would have to be low enough to offer the buyout equity investors the prospect of 30+ per cent rates of return and then the question is why the vendor (who, after all, knows the company better than anyone else) should let it go at that price. This leaves the other possibility, namely a disposal for reasons relating to broader corporate strategy.
Corporate finance is essentially a fashion industry. So disposals of profitable businesses for strategic reasons are also very common. But this can be even trickier to assess. The virtues of a focused 'core' business approach may later become discredited in favour of a diversified portfolio strategy. And even the definition of core business may be retouched so as to provide, say, for 'good management' as the core business in the case of a persistently successful conglomerate. Whatever the fashion, its followers generally seek to demonstrate that it will enhance shareholder wealth, and over the last 25 years or so both varieties have enjoyed extended spells of popularity.
Today the core business approach holds sway and 'unbundling' is the accepted way forward. Yet presumably the corporate financiers produced a no less telling rationale for the companies involved to 'bundle' in the first place. So if a company which is performing well is to be sold for strategic reasons, one would expect the price fully to reflect its potential value. Can a buyout compete? A management buyout can offer no synergies. The benefits of combining are absent if there is nothing to combine with. So the buyout is justified only if, taking into account the price to be paid and the benefit from gearing, the future profits and cash flow from the company, including its resale value - of which more later - are expected to produce an appropriate financial return to the buyer.
To support the case for a buyout, an enormous amount of analysis will normally be carried out, with the management of the target company typically centrally involved. This 'due diligence' process seeks to leave very little to chance and literally all of the available facts will be carefully assessed, together with likely movements in the variables believed to govern future performance. If this extensive analysis gives the buyout financier sufficient comfort, he will then offer that price which, after allowing for a healthy debt component in the consideration, remises an internal rate of return of, say, 35 per cent a year. Yet frequently and significantly more. And usually, he will have been denied the benefit of having the management's own detailed plans.
