by Nicholas Charman
“Banks sell back estate agencies” was a Sunday Times headline recently. The article under it went on to explain how the housing slump had caused the current recession in estate agency business, quoting losses by the financial giants in this sector, and giving examples of instances where agencies are being closed and, in some cases, being bought back by the individuals who sold them two or three years ago.
Our research shows that in many cases the individuals who received the large considerations for selling their agencies at the time are often no longer in the business. The agencies are, in many cases, being run by the managers who were not the beneficiaries of ownership of the agencies, but who are now in the senior management roles.
Our research shows that in many cases the individuals who received the large considerations for selling their agencies at the time are often no longer in the business. The agencies are, in many cases, being run by the managers who were not the beneficiaries of ownership of the agencies, but who are now in the senior management roles.
It is quite clear that for many managers in the estate agency subsidiaries of the large financial institutions there are opportunities for management buy-outs (MBO). Even if faced with the possibility of redundancy following closure of branches, you may be well placed to ensure your ongoing employment as your own “boss” by buying the business to be closed at a knockdown price.
But what is involved? How do you go about raising the finance for such a purchase if you do not have the money? How will the deal be structured so that you own the business — and not another financier?
Management buy-out
The acquisition of the business you are working for involves various aspects which are best thought through with a suitably experienced adviser, probably your accountant.
The first issue that needs to be sorted out is the feasibility of a deal. Lenders of money for MBOs are interested first, second and third in the quality of the management that will be running the new business. So the quality of your experience and management needs to be examined to see if it will pass muster for the purpose of attracting a backer. The absolute amount of money you have to put into the deal is less important, so long as you are prepared to put enough money into it to demonstrate your commitment, within the scope of your own personal financial ability.
You will need help to value the business. Realistic forecasts of likely revenues and costs will have to be worked up.
The likely price to be paid, along with the working capital needs of the business, will have to be estimated, and a financing structure will have to be thought out to accommodate the finance costs within the projected cashflows and profits of the business.
Negotiations with the vendor
You will have to negotiate a price with the owner of the business. The position of the employee or manager who wishes to buy his business from his employer is a very difficult one. You have to negotiate on an “arm’s length” basis with someone who, if it all falls through, has the ability to determine your future employment. It is indeed very like putting your neck on the block.
Having a neutral ground to meet on, the tempering presence of your adviser and his ability to negotiate on your behalf are all very useful in these circumstances, and can lead to less stress and a more “arm’s length” negotiation.
Business plan
You will have to identify your strategies and plans for the future, and you will also have to write a document to attract financial backers to the proposed investment. This is the “business plan”. An additional role for this document is that it will act as your ambassador, as it represents visible evidence of your ability as management to see objectives, strategies and risks clearly, and your ability to present them. This is important because the investor will be most interested in the quality of management.
It is clear then that this document is important. It must be concise, easily read and well presented. It must deal with a brief background to the business, its market, its management, its operational methods, the risks and financial projections. It must state clearly what funding is wanted and for what purpose the funds will be used.
The investor
The best investor for your management buy-out will depend on several factors. How much money is needed? What return is available? How much money will a bank lend? Bank lending depends on asset cover in the balance sheet and interest cover in the projected profit and loss accounts. How much will the management be risking? When and how can the external investor expect to get his money back (known as the “exit”)?
Introductions to the most likely investors by an intermediary, again probably your accountant, will improve your chances of obtaining an investor without undue delays and will avoid the undesirable “mail-shotting” of the many venture capitalists who are seeking good investments.
It may well be that the best investor will be a local entrepreneur, not a venture capitalist, and it may be possible to persuade your erstwhile owner and employer to leave part of his sale price in the business as a long-term investment.
This aspect will need careful consideration. Estate agency is in a down-cycle at present, which after all is why the opportunity will be presenting itself to you now.
A good time to buy a business is when it is at the bottom of its cycle, and commanding a low price. There would be little point in buying it when it is very successful and commanding a high price.
None the less, a case will have to be well presented to the right investor to attract him to this type of business. The investor will need to be convinced that a realistic assessment has been made of the likely time for continuing recession in this industry, and the business’ cash needs during this period.
Funding structure
Estate agency is generally not a capital-intensive business. No large investment is required in fixed assets beyond premises from which to operate and office and computer equipment. This implies that the extent of available borrowing from a bank will be restricted and that the majority of the funding will have to be “risk capital” — ie not secured against assets in the event of business failure and liquidation.
Risk capital takes many forms: ordinary share capital, preference share capital, subordinated or unsecured loans are the most common.
Ordinary share capital carries the most risk and is last to be paid out from available sources in the event of business failure; but an ordinary share usually carries a vote, and therefore the power of controlling the company lies in the ordinary shares.
Preference shares usually carry a right to a dividend as a percentage of the preference share capital subscribed. This dividend has to be paid in preference to any dividend on ordinary shares.
Subordinated loans are interest-bearing loans, which have rights to security subordinated below the rights of the fully secured lender.
Unsecured loans are loans which are not secured at all against the assets of the business.
Striking the right balance between these financing devices will be needed to ensure that the control of the business is in the right hands (hopefully yours!), that the return to the various investors is adequate, and that the business has not taken on too high an interest or dividend burden for its likely profitability.
The tax implications of the funding structure also need to be carefully considered so as to ensure the best likelihood of allowability for tax of all interest costs, including the costs of personal borrowing by the management for their investments, and to ensure no unforeseen taxation costs.
Completing the deal
Once a satisfactory price has been struck, and the funds have been found, the deal will need to be tied up legally. The process toward completion can be complex, and again it is best to be introduced to a legal representative who has the right experience to enable the deal to be done on time, and to negotiate satisfactorily with the legal representatives of the vendor, and of the backers.
There are many documents which need to be properly drawn up. Share subscription agreements, articles and memorandum of association for the company, sale and purchase agreements, disclosure letters and contracts of service are but the basic list. There will usually be others, depending on the circumstances.
Running the business
When you have achieved the goal of buying your own business, you are now at the start of your problems — running it! Life in charge of a small independent business is very different from the role of a manager within a large corporation. The pressures are all very immediate and you will probably be working longer and harder — but in your own, much more rewarding, environment.
Your ongoing relationship with your external investors will become very important to you, and you will be glad if you have chosen them wisely. You will be grateful for a funding structure which is right for the business, so that you are not fighting your way from cash crisis to cash crisis, but can spend your time developing your business from a sound footing.
