If you're quick on the draw, management buyouts are your chance to claim some territory, stamp your authority on it, and ride off into the sunset. But it's a dangerous business, and Boot Hill awaits for the unlucky and the unwary.
It's your chance to take control of the whole shooting match. The management buyout, whereby a company's management takes over a business from their corporate parents and strikes out on their own, is becoming increasingly common in the construction industry. Between 2001 and 2005, buyouts and buy-ins were valued at £1.64bn by the Centre for Management Buy Out Research, up 74% on the previous five years. Indeed, only banking and healthcare rival construction in the number of buyouts taking place. With opportunities so commonplace, we asked some experienced hands to take us through a process that is part endurance test, part demonstration of financial acumen and part bid for freedom.
1 The set-up
Usually, a buyout opportunity arises because a parent needs to sell, rather than because an ambitious managing director has plotted a takeover. Nigel Shilton, a real estate partner at consultant Deloitte & Touche, says: "Our experience is that more buyouts are driven by owners or shareholders who are looking for an exit strategy."
Such tactical withdrawals often stem from the aggressive growth and acquisition strategies followed by groups in the 1990s. Having created mini-conglomerates, the owners find that they cannot control all the parts of the business or ensure their profitability. An example of this is Gleeson, which sold its building division to managing director Martin Smout in August last year, having announced a £16.6m loss in its results for the second half of 2004.
Similarly, some contractors have decided to ditch their construction roots and move into support services, a strategy that led Carillion to agree to the buyout of French business Carillion BTP in October 2004. Others sell divisions that are geographically remote from the group headquarters: that was Atkins sold its US subsidiary Atkins Americas Holdings to a management team for £11m in 2003.
So, an opportunity presents itself to get your hands on the business. You do not want to risk working for a buyer that does not understand the business and, anyway, you have long-held plans for the firm. The desire to defend or salvage your firm's reputation may also be a strong incentive. A high-profile example was David Bucknall's buyout of Bucknall Austin in 2003. Five years after selling the business that his father had founded to the newly created Citex Group it went into administration, so Bucknall returned. He says: "I thought, ‘Blimey, 40 years of track record and now 300 people aren't masters of their own destiny; we'd better do something'."
For others, of course, the incentive is more financial than emotional. David Holliday led a £34m buyout of Kent-based Ward homes back in 2000. Just before he bought the business Ward was a loss-maker, but by 2004 its pre-tax profit was £13m. As a result of the success of the buyout, the value of the business has shot up and Holliday sold it for a tidy £70m.
2 Secure the cash
Jan Crosby, head of building and construction mergers and acquisitions at KPMG, says: "Funding can come from private equity, integrated finance, banks, asset finance and in some cases, vendor loan." With such an array of options, your first step will be to hire a financial adviser. They will tell you whether their buyout has a reasonable chance of success, they will work with you on the business plan and help to negotiate funding. Bob Bond, who completed the buyout of Sussex contractor Rydon Construction for £100m in January, selected KPMG, one of the "Big Four" financial services firms, as his adviser. He believed that this would send a message to the sellers that he was serious about buying the business. "I made that decision because I wanted to win; I didn't want to just play at this," he says. "To do it properly I felt that I had to employ a professional of equal standing to Pricewaterhouse Coopers, which was advising the vendors."
There are two main funding options. The first is to get a venture capitalist to back the deal. Buyouts funded by venture capitalists demand a fast growth rate, typically a doubling of the company's value within three years. Crosby says that relatively few construction buyouts are funded in this way: "Venture capitalists have a choice of business services sectors," he says. "They can choose something high growth and high margin, or a contractor that makes 1-3% margin. To double your money in three years in contracting is difficult, unless there are easy savings to be made or a particularly good order book."
This makes your presentation of the business to funders even more important. Crosby says: "Sustainable niches, framework contract underpinning, repeat work, exposure to ‘hot' sectors such as utilities and social housing all attract interest. Housebuilding with its hunger for cash and longer time horizons attracts a bank or integrated-finance-based funding package."
The second, and more common, funding option is to take out a bank debt or "integrated finance" deal, where the investor, typically a bank, will provide a loan and buy an equity stake in the company. This has a less demanding business plan than a venture capitalist would demand: the aim is to double turnover in five years. However, the team also has to provide "hurt money": personal borrowing or investment by the management team itself to guarantee its commitment to the company's success. The funder will calculate this based on the financial means of the directors. Tim Downing led a buyout last August of Birmingham-based construction and property consultant DBK Back. In that case,
one-third of the deal was funded out of the management's personal borrowing. "It's as tight as we would want it to be," Downing says. "It has certainly focused our attention on making sure we improve the bottom line."
3 Don't get distracted
Crosby says: "A buyout takes time and can severely distract management from the day-to-day running of the business. A good way of losing credibility and hence losing a potential funder is to consistently miss forecasts. Dividing responsibilities between management team members can help - often one focuses on the deal and others remain focused on the business."
Delegation therefore becomes an important aspect of a buyout bid. The management of north-eastern contractor Surgo Construction - known as Bowey Construction before a buyout in 2002 - was tendering for a £21m school academy contract in Middlesbrough while also drawing up terms for its bid. The team, led by the then deputy managing director and current managing director Ian Walker, delegated significant responsibilities to more junior colleagues, with hands-on control of the QS division passed down to two managing surveyors. "It was always part of our strategy to bring these guys on," says Walker. "They just had to step up a bit earlier than expected."
Running a business while pursuing a bid can be stressful. From first suggestion to final deal, the DBK Back buyout took eight months, which is actually relatively quick. "It didn't feel quick at the time," says Downing. "It becomes all-consuming." For six months, Downing, who was the managing director, spent three days a week working on the buyout, and he estimates that senior directors Duncan Berry and Steve Kelly were each contributing two days a week as well. "We did underestimate how long it would take and instead of working nine hours a day we were working 15," Downing says. "It does put pressure on you."
4 Watch out for rivals
Crosby says that planning how to beat trade buyers at an auction is one of the most important issues you will face. For a listed company, any buyout offer will be made public, the upshot of which may be to attract rival bidders. In the case of Countryside Properties' buyout last year, an initial bid by chairman Alan Cherry and his sons resulted in prolonged negotiation with an investment group that had taken a large stake in the company and indicated that it was prepared to make a rival bid. To secure the buyout, the Cherrys had to raise their price by £4m.
Being up against rival bidders can present potential conflicts of interest, as management finds itself in the conflicting position of being a possible buyer and a senior administrator for its sale. For example, the board of the Rydon Group insisted that Bob Bond make a series of presentations on the business to potential buyers before permitting him to mount his own bid. "I didn't want to present it to other bidders: I wanted to buy it myself. But I had a fiduciary duty as a director to do what the shareholders wanted me to do, which was to get the best price for the business."
5 Don't fail …
Buyouts are a risky business, and banks will do their utmost to make sure their investment is a safe one. This will involve an extensive due diligence investigation. Surveyors might come in to look at the housing stock of a residential builder and others will examine the state of the firm's pension plan. It's not only a financial healthcheck - it can include psychometric testing of the management or even watching them perform in a mock debate.
"Underestimate due diligence at your peril," says Crosby. "The areas looked at in detail include financial, legal, property, planning/surveying, contracts, insurance, health and safety, environmental, pensions, IT, management and commercial (which typically includes some form of customer survey). This takes a lot of time, effort and money, but there is no avoiding it."
However, even accounting for due diligence, buyouts sometimes end up failing because they are "thinly capitalised", according to a director that recently saw his firm collapse. Essentially, most of the money in the business is ploughed into paying back banks and/or venture capitalists, which means there is little cash available to cover contract hits. Also, a venture capitalist is often inclined to write off the money it has spent on the business rather than risk any more by covering major cash flow problems.
This is particularly dangerous if a company is growing quickly. Edinburgh contractor Peter Walker Group, which is 127 years old, went into receivership last month just five years after a buyout. High overheads and unprofitable contracts left it in a severe cash flow crisis, just two months after managing director Alastair McCorry said it was looking to expand into housebuilding. With a powerful parent company, businesses like Peter Walker would have greater financial backing to help them survive.
But many executives that have completed a buyout are certain that it is worth the risk. Despite being well into his 60s, Bucknall Austin's David Bucknall got a real buzz when he led the buyout to bring the company back under management control: "It's extremely intense. You get to see where the City adrenaline junkies live." Rydon's Bond perhaps sums up the go-it-alone spirit best.
"It's a great feeling, a completely different feeling," he says. "From the moment you drive in in the morning, you only have to answer to yourself."