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International Journal of Entrepreneurial Behaviour & Research, Vol. 6 No. 1, 2000, pp. 21-40.
#MCB University Press, 1355-2554
Secondary management
buy-outs and buy-ins
Mike Wright, Ken Robbie and Mark Albrighton
Centre for Management Buy-out Research, University of Nottingham, Nottingham, UK
Keywords Management buy-outs, Venture capital, Buy-ins, Entrepreneurs
Abstract This paper provides an exploratory examination of the growing phenomenon of
secondary management buy-outs and buy-ins, where an enterprise having initially been bought out by management is later the subject of a secondbuy-out or buy-in. Such transactions provide a further dimension to the exit opportunities available to venture capital investors and also to the maintenance of independent entrepreneurial businesses. The paper uses large scale data to test propositions relating to the expected differences between secondary outs and ins and buy-outs and buy-ins in general as well as detailed case study evidence from entrepreneurs and venture capitalists to examine the rationale for such transactions. The quantitative data suggest that secondary buy-outs and buy-ins are more likely to involve enterprises in traditional industrial sectors andare significantly more likely to occur a longer time after the initial buy-out than are trade sales or flotations. The case study evidence reveals that secondary buy-outs and buy-ins can arise for various reasons but are rarely the first choice exit route for venture capitalists, though they provide a means by which entrepreneurs can maintain the enterprise's independent private existence.
I Introduction
The development of management buy-outs and buy-ins over the last 15 years or so has brought a new type of entrepreneurship which extends the traditional notions of entrepreneurs and entrepreneurship involving the founding or inheritance of a new venture (Cooper and Dunkelberg, 1986; Ennewet al., 1994). There has also been recent growing interest in habitual entrepreneurs, individuals who found, inherit or purchase more than one business (Westhead and Wright, 1998; Wrightet al., 1997b). Consideration of the different types of habitual entrepreneur considerably broadens our understanding of the notion of entrepreneurship.
While attention has primarily been focused on multiple different ventures by the same entrepreneur, an increasingly important subset of the phenomenon concerns multiple or serial ownership change of the same business entity. As venture capital and the associated buy-out and buy-in markets mature, the longevity and life-cycle of such entrepreneurial organisational forms begins to emerge (Bygraveet al., 1994; Relanderet al., 1994). Increasing numbers of buy-outs and buy-ins are floated on stock markets or sold to other groups (CMBOR, 1998). As part of this trend, recent
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years have seen an increase in the number of buy-outs and buy-ins in the UK which have exited by means of a secondary or secondary management buy-out or buy-in. In 1996, secondary buy-buy-outs and buy-ins accounted for 13.3 per cent of all exits, a marked increase from the 8.5 per cent in 1994, and 11.4 per cent in 1995.
The development of secondary buy-outs and buy-ins raises important issues regarding the life-cycle and longevity of this form of organisation as well as issues relating to the manner in which venture capital firms realise the gains on their investments. There has been considerable debate about the longevity of buy-outs (Jensen, 1989; Rappaport, 1990; Kaplan, 1991; Wrightet al., 1995) and examination of secondary buy-outs and buy-ins may shed new light on whether buy-outs are a long term organisational form. Secondary buy-outs and buy-ins bring a new dimension to the exit options available to venture capital firms in addition to the more traditional stock market flotation or sale to a third party (Bygrave et al., 1994; Relanderet al., 1994). As yet, however, the extent, nature and rationale for secondary buy-outs and buy-ins is not well-understood.
These transactions represent a number of options which may involve complete, partial or no change in incumbent management and/or complete, partial or no change in venture capital providers. A secondary transaction with no change in management and partial or full change in the venture capital firms providing funds may occur where some or all of the venture capital firms seek to realise their investments. In such circumstances, one or more of the exiting venture capital firms may be replaced by new incoming funds providers. Alternatively, some or all of the incumbent management team may be replaced by new entrepreneurs, possibly at the instigation of the venture capital firm as a result of poor performance. In some cases, there may be a change in both some management and some of the funds providers. As a result of these combinations of changes, the ownership and financial structure of the business changes to create a secondary buy-out or buy-in.
The purpose of this paper is to provide an exploratory analysis of multiple changes in ownership of the same business venture which create and maintain entrepreneurial independent businesses. First it presents, using quantitative evidence from the authors database, an analysis of the nature and extent of secondary management buy-outs and buy-ins. Second, it presents evidence from case studies on the rationale and motivations for undertaking a secondary buy-out or buy-in.
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II Theoretical perspectives
Considerable theoretical debate exists concerning the life-cycle and longevity of management buy-outs and buy-ins. Jensen (1989) argued that buy-outs are a new long-term form of organisation, while Rappaport (1990) suggested that they were simply a transitional form which enabled the investing parties, management and financiers, to gain at the expense of outgoing shareholders. Empirical evidence suggests that the life-cycle of buy-outs is heterogeneous (Kaplan, 1991; Wright et al., 1995); some buy-outs change very quickly to become quoted on a stock market or part of a larger group, others remain as buy-outs for considerable periods. Key issues for understanding the development of secondary buy-outs and buy-ins concern the factors which influence the longevity of buy-outs and the form taken by the non-failure exit from a buy-out or buy-in, that is flotation, sale to a third party or secondary buy-out or buy-in.
Wrightet al. (1994) provide a conceptual framework for understanding the life-cycle of management buy-outs and buy-ins. They argue that the longevity of a management buy-out or buy-in is influenced by three main factors ± the nature of the enterprise and of the market, the aims and objectives of incumbent management and the aims and objectives of financiers. The relative importance of these factors may differ across different buy-outs and help to explain the heterogeneity of the buy-out life-cycle. We consider the implications of each of these aspects in turn for the development of secondary buy-outs and buy-ins.
With respect to the enterprise itself, companies with strong growth prospects may in general be able to achieve a listing on a stock market as a means of accessing new capital. However, there are increasing problems in listing smaller companies in the UK. Lack of interest by large institutional investors in smaller stocks and hence lack of liquidity in company's shares has caused problems for floating medium-sized buy-outs both in respect of secondary tier stock markets, such as the new defunct Unlisted Securities Market (USM) (Fassin and Lewis, 1994; Peeters, 1994). It also appears to be coming increasingly problematical because of changing institutional investors' attitudes in the late 1990s to float companies on the main market of a size which would previously have been acceptable (see e.g. Willman, 1998; London Stock Exchange, 1998; CMBOR, 1998).
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prospects for synergy (Mueller, 1988; Brealey and Myers, 1996; Hughes, 1993). However, the attractiveness to strategic buyers may also be a function of the size of an enterprise. As the mirror image of the rationale for divestment, it may not be economic for acquirers to purchase buy-outs or buy-ins which are too small to warrant the costs of integration and where the marginal contribution will be insignificant given the size of the parent. Murray (1994) identifies this as a problem for exiting early stage venture-backed transactions. It is proposed, therefore, that secondary buy-outs and buy-ins are more likely to have originated as subsidiaries of larger groups than is the case for buy-outs and buy-ins generally. It is also proposed that increasing problems in exiting modest sized enterprises through both flotation and trade sales routes will mean that secondary buy-outs will be more likely to be medium-sized than are buy-outs and buy-ins generally. It should be noted that around three quarters of medium-sized buy-outs and buy-ins are venture-backed, and hence face pressures to exit, whilst the majority of smaller buy-outs and buy-ins receive only clearing bank financing and do not face the same exit pressures (CMBOR, 1998).
P1a: Secondary buy-outs and buy-ins will be more likely to be medium-sized enterprises than are buy-outs and buy-ins generally.
P1b: Secondary buy-outs and buy-ins are more likely to have originated as subsidiaries of larger groups than is the case for buy-outs and buy-ins generally.
Similar arguments to those outlined above might be advanced in respect of outs of family businesses, which tend on average to be smaller than buy-outs and buy-ins in general. Since a rationale for the sale of a family business as a buy-out is often to maintain its independent identity (Wright and Coyne, 1985), it may be expected that a secondary buy-out or buy-in provides a means of allowing the initial financier to exit whilst prolonging the enterprise's independent existence.
P1c: Secondary buy-outs and buy-ins are more likely to have originated as buy-outs or buy-ins of private/family businesses than is the case for buy-outs and buy-ins generally.
Some companies may fit the classic buy-out and buy-in idea of being in niche markets (Jensen, 1989). These companies may have stable markets but may have little prospects for growth. In such cases, continued independent existence may be feasible where a secondary buy-out or buy-in is necessary to meet the objectives of management and financiers. It is proposed, therefore, that secondary buy-outs and buy-ins are more likely than buy-outs and buy-ins generally to be in niche markets, such as traditional manufacturing industrial sectors which may be more likely to have lower growth prospects.
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Incumbent management may seek to grow the business through flotation on a stock market. Alternatively, they may see their career developing through selling the buy-out or buy-in to another group and subsequent advancement within the parent company (Birley and Westhead, 1990; Relanderet al., 1994). They may also see themselves exiting at these stages and either founding or buy-ing into a new venture, becoming serial entrepreneurs in the process (Westhead and Wright, 1998; Wright et al., 1997b). Evidence from representative samples of the buy-out and buy-in populations indicates that flotation and trade sale are clearly the preferred exit routes (Robbie and Wright, 1996); it is only a small proportion of buy-outs and buy-ins, however, which exit in the manner anticipated at the time of the initial transaction. Further evidence also shows that the motivations and objectives of management at the time of the initial transaction emphasise the importance attached to wanting to control ones own business and a long term faith in the company (Wrightet al., 1990).
Management may, therefore, seek to retain the business as a privately owned independent entity in the long term. This too, may be for differing motivations. Management may take the view that their objectives can best be met by becoming a long term privately owned independent business, which avoids the scrutiny of stock market analysts and minimises the threat of a hostile takeover. Petty et al. (1994) provide evidence from US entrepreneurial ventures that trade sales may enable investments to be realised in cash but may not satisfy entrepreneurs' objectives for continued control of an independent business. A variation is where senior management who conducted the initial buy-out seek to retire or exit for other reasons but where second tier management are in place and are able to move into the position of being lead management. In these cases, we propose that managers see the secondary buy-out or buy-in as a long-term organisational form. The management in these secondary buy-outs and buy-ins will need to identify means of buying-out the equity stakes of the investors in the second venture whilst remaining independent. It may be expected, therefore, that this subset of enterprises will become the subject of tertiary buy-outs or buy-ins. In this sense, these secondary buy-outs and buy-ins may be a new means of extending the already complex notion of family businesses (Westhead, 1997).
P2a: Where management are motivated strongly by maintaining control of a private company, secondary management buy-outs and buy-ins may be a long-term organisational form, becoming tertiary outs and buy-ins in the fullness of time as successive equity investors need to realise their gains.
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horizon required by the funding venture capitalist. In these cases, we propose that management see the secondary buy-out as a transitional phase with stock market flotation or trade sale as an eventual exit option.
P2b: Where management are motivated to continue incomplete restructuring, the secondary buy-out or buy-in is expected to be a transitional organisational form.
The other interested parties are venture capitalists. Equity funding for buy-outs may be provided by captive venture capital firms who received funds from their parent company or from independent funds which raise finance from a number of institutional sources. While the former may be given some form of time horizon for providing returns, it is likely to be more flexible than for independent firms who have raised closed-end funds with a limited time horizon (Murray, 1991). The pressure on venture capitalists to realise their investment in a particular venture may be greater where a closed-end fund is reaching the end of its life since the venture capitalist will be obliged to return cash to its investors. Venture capitalists typically seek a dividend and capital gain on their investment within a particular time period. For the venture capitalist, evidence suggests that trade sales followed by stock market flotations are the preferred means of harvesting their investments in buy-outs and buy-ins (Wrightet al., 1993). However, although a preferred exit route may be established at the time of the first deal, venture capitalists are typically flexible about the actual exit route, keeping it under review as the company develops (Relander et al., 1 994). It is proposed that it is unlikely that a secondary buy-out or buy-in will have been a stated preferred exit route at the time of the initial buy-out or buy-in.
P3a: Secondary buy-outs or buy-ins are unlikely to be a stated preferred exit route at the time of the initial buy-out or buy-in.
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These investments may be potentially attractive. However, restructuring may not yet have been effective because of, for example, macroeconomic or sectoral difficulties. It is not possible to float these companies on a stock market and they may be unattractive to strategic buyers. A secondary buy-out or buy-in may provide a means by which initial investors facing time pressures can achieve an exit. These time pressures may arise from a venture capital firm's own target investment horizons or from pressures arising from limited life closed-end funds. It is proposed, therefore, that secondary buy-outs and buy-ins may be appropriate exit routes for venture capitalists with closed-end funds under time pressures to liquidate the remainder of their portfolios which contain investments which have yet to achieve their potential.
A major issue arises which concerns why other venture capitalists will be attracted to investing in companies from which the initial venture capitalist is exiting. Asymmetric information arguments would suggest that venture capitalists will be suspicious of the motives of other venture capitalists wishing to sell (Admati and Pfleiderer, 1994). As a result, the market may be expected to break down. However, where initial venture capitalists are able to signal information that companies fall into the ``good rump'' rather than the ``living dead'' category and have good prospects, the conditions may be established for the market to function. This condition may be reinforced where venture capitalists in closed-end funds are able to signal that it is the limited life of these funds which creates the pressure to exit at this particular point in time. From the early 1990s, venture capital firms in the UK which obtained their finance through closed-end funds increasingly found themselves to be subject to these pressures. It seems likely that the relatively small nature of the venture capital industry and the close links between venture capitalists through deal syndication and reciprocation (Murray, 1991; Wright and Robbie, 1996) meant that it became easier to convince potential funders of secondary buy-outs and buy-ins that the reasons for an initial venture capital firm's exit were genuinely based on time pressures.
P3b: Secondary buy-outs and buy-ins may be appropriate and feasible as exit routes for venture capitalists seeking to meet their investment time horizon targets and especially those with closed-end funds who are under time pressures to liquidate the remainder of their portfolios which contain investments which have yet to achieve their potential.
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Although the company may have good prospects, the problem may lie with the incumbent management. In such cases, the venture capitalist may seek to create a secondary buy-out or buy-in in order to replace existing management. While venture capital firms may replace management when a company is under-performing, this power is likely to be used sparingly (Sweeting, 1991), not least because of the time demands it puts on the venture capital firm and the difficulty in replacing managers who may have a majority of the equity and who contribute major specific skills to the transaction. Arriving at a position where it is feasible to replace management in this way is likely to take some time. For these reasons, it is proposed that the time elapsed since the first buy-out at the time a secondary transaction takes place will in general be greater than that in respect of flotations and trade sales.
P3c: The search for alternative (preferred) exit routes will mean that the time elapsed since the first buy-out or buy-in at the time a secondary transaction takes place will in general be greater than that in respect of flotations and trade sales.
P3d: Secondary buy-outs and buy-ins may be appropriate where venture capitalists consider there is a need to replace management in order to improve the performance of the company prior to a full exit.
III Data and methodology
The methodology adopted in this paper is a two-stage one. The first stage utilises the authors' database of management buy-outs and buy-ins in the UK. This database, which constitutes the effective population of management buy-outs and buy-ins in the UK, covers transactions from before 1980 until the present. The database is continually updated from a number of sources. Primarily, the data are compiled from a twice-yearly survey of all financiers of management buy-outs and buy-ins in the UK. Other sources of data include intermediaries, systematic searches of company accounts, Extel cards and the financial press. Once entered into the database, companies are subsequently monitored, with exits being identified through similar sources to the above, plus flotation documents where relevant. This data capture and monitoring procedure for the database enables both initial and secondary buy-outs and buy-ins involving the same company to be identified.
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In order to examine the rationale for secondary buy-outs, the second stage involved case studies of 13 secondary management buy-outs and buy-ins, during the period July-September 1996. Face-to-face interviews were conducted with either the chief executive, managing director or, in one case, the finance director. The research was conducted using a structured questionnaire which was sent after the directors had agreed by telephone to participate in the study. All the companies interviewed had undergone their secondary management buy-out within the last five years, with the majority occurring within the last three.
IV Quantitative analysis
Secondary buy-outs and buy-ins have occurred in increasing numbers over the last decade (Table II). A first peak of activity occurred in the late 1980s, after which there was a marked decline at the beginning of the 1990s. From 1993 onwards numbers have increased noticeably. Indeed, over a half of all the 229
Table I.
First and secondary buy-outs and buy-ins Secondary buy-out Secondary buy-in Total sample
No. Percentage No. Percentage No. Percentage
First buy-out 157 86.3 34 72.3 191 83.4
First buy-in 25 13.7 13 27.7 38 16.6
Total sample 182 100.0 47 100.0 229 100.0
Source:CMBOR/BZW Private Equity/Deloitte & Touche Corporate Finance
Table II.
Note:There was one deal for which the date and other data could not be identified
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secondary buy-outs and buy-ins identified by CMBOR have been completed in the last four years. In 1996, the peak year to date, they accounted for 5.9 per cent of all new buy-out and buy-in completions.
Value ranges
It was proposed earlier that secondary buy-outs and buy-ins are expected to be more prevalent among medium sized deals (Table III). These are transactions which in the 1980s could have been possible flotation candidates. However, the generally reduced willingness of institutional investors to invest in these more modest sized enterprises in the 1990s, as outlined in the previous section, indicates that this was no longer a valid exit option. Additionally, most deals in this size category are venture backed, frequently by firms with closed-end funds which have limited time horizons. The table shows that although there are some indications that secondary buy-outs and buy-ins are more prevalent among medium sized deals, the difference is not statistically significant at conventional levels. A Kolmogorov-Smirnov test and a Mann-Whitney test were used as the data are skewed, the resulting significance levels being 0.256 and 0.130 respectively. We are, therefore, unable to support propositionP1a.
Sources
Table IV provides evidence on the original source of the first buy-out or buy-in prior to it becoming a secondary transaction. These sources show few divergences from the picture for buy-outs and buy-ins in general. There is evidence that privatisations are more prevalent among secondary buy-outs and
Table III.
Values of secondary buy-outs and buy-ins
Value range Secondary All
Less than £1m 32.6 38.2
£1m-£5m 37.1 35.7
£5m-£10m 12.9 9.7
£10m-£25m 10.3 8.8
£25m plus 7.17.6
Total 100.0 100.0
Source:CMBOR/BZW Private Equity/Deloitte & Touche Corporate Finance
Table IV.
Initial deal sources of secondary buy-outs and buy-ins
Source Secondary All
Receivership 7.3 8.1
Divestment 52.6 53.9
Private/family 34.5 33.3
Privatisation 4.7 3.8
Going private 0.9 0.9
Total 100.0 100.0
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buy-ins than for buy-outs and buy-ins generally, whilst the reverse is true in respect of buy-outs involving receiverships businesses. There is little difference for private/family businesses and divestments. Therefore, propositions P1b
andP1care not supported.
Industry
There are marked differences in the characteristics of secondary buy-outs and buy-ins and the population of buy-outs and buy-ins as a whole (Table V). Secondary buy-outs and buy-ins are represented to a greater extent than might be expected given the industry distribution of all buy-outs and buy-ins, especially in mechanical engineering, metals, shipbuilding and vehicles, paper, printing and publishing and primary industries. To a lesser extent, secondary buy-outs are also over-represented in the chemicals sector and electrical engineering sectors. The corollary is that there are lower proportions of secondary buy-outs and buy-ins than might be expected in business and financial services, construction, furniture and timber and wholesale distribution. Significant differences in the industrial distributions of secondary and all buy-outs and buy-ins were identified with a chi-squared test yielding a value of chi-square of 40.18 (sig. at 0.001 level). Proposition P1d is therefore supported.
Exits from first buy-outs
The average age at which first buy-outs and buy-ins became secondary deals was a little over six years (Table VI). Secondary buy-outs and buy-ins on average occur 30 months after floats and two years after trade sales would be
Table V.
Industry distributions of secondary buy-outs and buy-ins
Secondary All
Primary industries and energy 3.5 1.1
Food, drink and tobacco 2.7 3.7
Chemicals and man made fibres 3.12.1
Metals 6.9 4.4
Mechanical and instrument engineering 10.4 8.8 Electrical engineering and office machinery 9.3 8.6
Shipbuilding and vechicles 6.9 3.3
Textiles, leather, footwear 4.6 4.4
Construction, timber and furniture 3.16.4
Paper, printing, publishing 9.3 6.7
Other manufacturing 5.8 6.8
Transport and communication 5.0 5.1
Wholesale distribution 5.4 8.4
Retail distribution 5.6 5.4
Business, financial and other services 18.5 24.5
Total 100.0 100.0
Sample number 228 6,592
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expected. These findings help to confirm impressions that secondary buy-outs and buy-ins frequently arise when other exit routes are not feasible. An F-test of the difference in the mean times to exit of secondary buy-outs, trade sales and floats yielded an F-value of 52.29 (df.2; sig. level 0.001). There was clear evidence, therefore, in support of propositionP3c, that exits by secondary buy-out would take significantly longer than exit by trade sale or flotation.
The age at which first buy-outs and buy-ins become secondary deals varies considerably (Table VII). A quarter had occurred when the first out or buy-in was four years old or less with a half occurrbuy-ing withbuy-in about six years. In approaching three tenths of cases, the first buy-out or buy-in had been established for between six and ten years, with the buy-out or buy-in being in excess of ten years old in nearly 15 per cent of cases (14.9 percent).
V The rationale for secondary buy-outs and buy-ins
Using evidence from the case studies, as discussed in the data section, we provide insights into propositions P1 and P2 concerning managers' and financiers' perspectives on secondary buy-outs and buy-ins. The features of the cases are summarised in Table VIII[1]. For convenience of exposition, the structure of the analysis in this section follows the chronological stages from first to second buy-out or buy-in in terms of the exit preferences stated at the
Table VI.
Period to exit (months)
Type of exit Mean Median Sample
Secondary 73.6 69.0 208
Trade sale 49.5 42.0 828
Flotation 43.7 34.5 358
Source:CMBOR/BZW Private Equity/Deloitte & Touche Corporate Finance
Table VII.
Age at time of secondary buy-out or buy-in
Age at time of secondary buy-out/buy-in (years)
Percentage of sample
Cumulative percentage of sample
Less than 1 1.3 1.3
1-2 3.5 4.8
2-3 11.4 16.2
3-4 8.8 25.0
4-5 11.0 36.0
5-6 11.4 47.4
6-7 11.4 58.8
7-8 8.3 67.1
8-9 12.7 79.8
9-10 5.3 85.1
At least 10 14.9 100.0
Note:Based on 228 companies for which data are available
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time of the initial buy-out/buy-in, the factors influencing the decision to undertake a secondary buy-out/buy-in and the expected exit route from the secondary buy-out/buy-in.
Initial buy-out/buy-in exit preferences
The interviews provided support for the proposition that a secondary buy-out or buy-in was unlikely to be a stated preferred exit route at the time of the initial buy-out (P3a). The most preferred exit routes from the first deal for the management involved in secondary buy-outs had been in order of declining importance, flotation, trade sale, and share buy-back. None of the companies interviewed had considered a secondary buy-out or buy-in as a possible exit route at the time of the first deal.
Six of the interviewees had expressed a preference for a flotation in order to have a continuing influence in the company, to realise part of their investment, to raise finance for the company more easily and to add prestige to themselves and the company. Four interviewees had preferred a trade sale for reasons which focused on an aversion to dealing with institutional investors, the lack of their company's suitability for a flotation, and because it provided an opportunity to remain with the company as managerial employees.
Only one company had stipulated at the time of the first buy-out that they preferred to exit through a share buy-back. This was agreed in principle by the venture capital firm with the option that if the management could not raise the funds within four years an alternative exit would be proposed. Two years after the buy-out, management had raised sufficient funds through personal finance and loans to provide the venture capital firm with a satisfactory return. The other interviewees had not made specific exit plans.
It was also clear from the interviews, however, that at the time of completing the original buy-out no serious consideration was given to alternative exit routes if the first preference was not met. This was especially important as the recession of the early 1990s delayed many planned exits. Had the original exit
Table VIII.
The secondary buy-outs interviewed
Company 1st deal Year Reason 2nd deal Year
A MBO 1986 Non-core activity MBO 1994
B MBO/I 1990 Retirement MBO 1995
C MBO 1984 Retirement MBO 1989
D MBO 1990 Pending receivership MBO 1995
E MBO 1985 Non-core activity MBO 1993
F MBO 1990 Receivership MBO 1994
G MBO 1990 Management retired MBI 1994
H MBO 1986 Alternative to closure MBO 1995
I MBO 1987 Non-core activity MBO 1992
J MBO 1992 Non-core activity MBI 1995
K MBO 1981 Non-core activity MBI 1995
L MBO 1988 Group divestment MBO 1996
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not been delayed, managers were of the view that they would not have considered a secondary buy-out. This finding helps to underscore the evidence presented above in support of propositionP3c.
Exit from the first deal
The evidence from the case studies emphasise the heterogeneous nature of the rationale for secondary buy-outs and buy-ins (Table IX).
The secondary buy-outs in six companies arose where managerial issues were particularly important. In three of these cases, the aspects of managerial issues provide some support for propositionP2a. In company K, the buy-out leader retired, and with no managers with sufficient expertise to ensure succession, attempts were made to find a trade buyer. These failed because of concerns that a trade sale would threaten the continuity of the business. As a result, the venture capital firm proposed the introduction of an outside manager to create a secondary buy-in with the retiring manager retaining a preference shareholding. In company M, the management team split on agreed terms, the departing manager taking over the non-core activities in a second buy-out and the remaining management retaining the core interests. In contrast, friction in the two-man management team in company B was highlighted when new venture capital firms approached for finance to repay terms loans were prepared to support only one manager. The result was a replacement of the original venture capital firm and the departure of the other manager.
In the other three companies, the secondary buy-out/buy-in occurred as further finance was required to continue managements' growth strategy, providing support for proposition P2b. Company D experienced problems in meeting repayment schedules coming out of recession and decided to seek
Table IX.
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further finance to enable them to penetrate export markets. The venture capital firm took the view that in order to acquire the funding another venture capital firm should be approached. As a result, the management's equity stake was diluted. A similar situation occurred in company G, except when further finance was requested, the venture capital firm replaced the manager with an inexperienced buy-in team. This resulted in the dismissed manager being reinstated to form a secondary buy-out/buy-in. Company H was also seeking further growth finance, but as it was the only investment in the venture capital firm's fund it was suggested that another venture capital firm should be sought who was more familiar with the company's industry.
Five of the companies underwent a secondary buy-out to buy-back the venture capital firm's equity stake, providing some support for proposition
P3b. In two companies, the secondary buy-out/buy-in arose as a direct consequence of venture capital firms seeking to exit because of the pressures of limited life closed-end funds. As attempts were made to find trade buyers, but a secondary buy-out was found to be the most feasible exit option, support for proposition P3c is also provided. In case C, management, having been prompted to find a trade buyer by the venture capital firm and succeeding in doing so, realized during the negotiations that they could raise the finance themselves. Once approached, the venture capital firm supported a secondary buy-out. Management had achieved significant growth and took the view that it was preferable to continue along this route rather than becoming managerial employees in a large group. In company L, plans for a flotation were thwarted for technical reasons and two trade sale attempts failed to reach agreement. A secondary buy-out was adopted as a means of meeting the venture capital firm's time constraints.
In the other three cases, the timing of the exit was prompted by the venture capitalist's desire to realise its investment within a particular time period, but in the absence of closed-end fund pressures. At company E, the buy-out had been in existence for eight years when the venture capital firm decided it wanted to exit, and this was achieved through the venture capital firm proposing a special dividend to meet the valuation placed on the company's shares. Company I had initially planned to float, but when this did not look likely the venture capital firm discussed a potential trade sale. This did not appeal to management, who felt that as they were still 20 years from retirement they had much to offer the company. The management approached the venture capital firm with a buy-back proposal and raised the £2 million in loans to meet the venture capital firm's price. Company J had planned a buy-back at the time of the first buy-out and this was achieved two years earlier than planned because of strong performance.
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the same time, management expressed a desire to undertake a secondary buy-out but were dissuaded by the venture capital firm on the grounds that this could reduce interest from potential trade bidders. After a period of time it became evident that the venture capital firm would not achieve the valuation they were seeking from a trade bidder and it was decided that a secondary buy-out could go ahead if management could raise the agreed level of finance. The successful Company F's management had originally targeted a trade sale as an exit route, but their advisers suggested that it would also be prudent to consider a buy-out refinancing. When the offers were received it became evident that venture capital firms were offering the highest price for the equity. As a result, the management decided to sell part of their equity stake to a venture capital firm and undergo a secondary buy-out.
It was suggested earlier that a major factor in triggering a secondary buy-out or buy-in from the point of view of venture capitalists was the need to change management (propositionP3d). Support for this proposition was found from the interviews, as the management teams involved in the secondary buy-outs interviewed had either changed completely or partially. In six companies, there had been partial changes consisting of either some members leaving and not being replaced or the bringing in of new members. Excluding those managers who became buy-in members, the changes that occurred were: dismissal of members of the management in three companies; retirement of members in two companies; voluntary departures in four companies; and the forced sale of managerial equity stakes by the venture capital firm in one case.
Exits from the seconddeal
It was proposed earlier that some secondary buy-outs and buy-ins were expected to be long-term organisational forms (propositionP2a) whilst others were likely to be transitory (propositionP2b). Our case study findings provide support for both of these propositions. Management generally reported their main reason for undergoing a secondary buy-out as an aversion to becoming managerial-employees and a desire to remain with and exert a continuing influence in their company by aiming to keep it independent, at least for some time.
In support of proposition P2a, the management in six of the companies intended to stay with the company until retirement. Given that most of these managers had between 15 and 20 years of their career still to run, this indicates that the maintenance of the company as a long-term privately owned independent business was a major objective. All these managers owned majority equity stakes in their companies and were prepared to undertake further refinancing (i.e. a tertiary buy-out) in order to maintain their independence.
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of £10 million. A further two of the companies had considered a trade sale as the proposed exit route, one of which was already negotiating the terms of their trade sale two years after the second buy-out. The other company reported that it would only pursue a trade sale if the correct price is offered. If this is not the case, the aim is to achieve a third management buy-out. These findings provide support for propositionP2b.
The remaining company had no explicit exit strategy other than to develop the company. There was some evidence that managers intending to remain, as private independent companies were seeking growth through organic development, whereas those seeking a stock market flotation also placed emphasis on acquisitions. Whether they wished to remain as an independent company indefinitely or not, management reported a greater influence in determining exit horizons in the second buy-out than they had in the first.
VI Summary and conclusions
This paper has involved an exploratory study of secondary management buy-outs and buy-ins. The main findings of the study are as follows. Over a half of all the 229 secondary buy-outs and buy-ins identified by CMBOR have been completed in the last four years, with a peak of 38 being completed in 1996. Almost four fifths of secondary deals are buy-outs.
There was mixed support from the quantitative analysis for the propositions outlined earlier in the paper. In line with expectations, the most marked differences between secondary buy-outs and buy-ins and buy-outs and buy-ins generally are in relation to industrial distributions. Secondary buy-outs and buy-ins are represented to a greater extent than might be expected, given the industry distribution of all buy-outs and buy-ins, especially in more traditional manufacturing sectors. Expectations that the average age at which first buy-outs and buy-ins became secondary buy-buy-outs and buy-ins would be significantly longer than for flotations and trade sales were supported. In contrast, secondary buy-outs and buy-ins were not significantly more prevalent among deals which were originally from divestments or family firms. Although secondary buy-outs and buy-ins were somewhat more prevalent among medium sized transactions, the differences were not statistically significant. The absence of statistical differences with respect to the latter propositions is perhaps an indication of the heterogeneity of enterprises which become buy-outs and buy-ins with particular size ranges and from particular sources.
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original venture capital firm is not prepared to support such a growth strategy; a requirement to raise finance to meet the venture capital firm's repayment time scale; incumbent management express a desire to retire; management want to remain as an independent private company; conflicts of interest among the management team members; poor performance leading to the dismissal of part of the management team and the introduction of outside managers; the highest exit price can only be obtained through restructuring as a secondary buy-out or buy-in with a new venture capital firm.
Secondary buy-outs and buy-ins frequently take place after unsuccessful attempts to conclude a trade sale, either because the price is insufficient or management are able to exert their preference for remaining as a private independent company. Managers in secondary buy-outs and buy-ins differ in their exit intentions, but the most frequently cited exit route was to maintain the company's private independent existence through share buy-back and refinancing, followed by flotation.
Although the case study evidence emphasises the heterogeneous rationale for secondary buy-outs and buy-ins, there are clear limitations in generalising from these findings. It should be borne in mind, however, that the case study evidence presented in this paper is intended to provide exploratory evidence on the dimensions of the rationale for secondary buy-outs and buy-ins. Further quantitative research is required to investigate both the relative importance of the factors influencing the decision to undertake a secondary management buy-out or buy-in and any links between these rationale and subsequent performance and longevity.
Note
1. Because of confidentiality undertakings, information on the cases is presented anonymously.
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