Directory UMM :Data Elmu:jurnal:I:International Journal of Entrepreneurial Behaviour & Research:Vol6.Issue1.2000:
Secondary management
buy-outs and buy-ins
Secondary
buy-outs and
buy-ins
Mike Wright, Ken Robbie and Mark Albrighton
Centre for Management Buy-out Research, University of Nottingham,
Nottingham, UK
21
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 second buy-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 buy-outs and buy-ins and buyouts 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 and are 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; Ennew et 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; Wright et 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 (Bygrave et al., 1994; Relander et 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
Financial support for CMBOR from Deloitte & Touche and Barclays Private Equity is
gratefully acknowledged. Helpful and constructive comments from the editor and two
anonymous referees is acknowledged with thanks. The research assistance of Velda Hunter in
the case study analysis of this article is acknowledged.
International Journal of
Entrepreneurial Behaviour &
Research, Vol. 6 No. 1, 2000, pp. 21-40.
# MCB University Press, 1355-2554
IJEBR
6,1
22
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 buyout or buy-in. In 1996, secondary 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; Wright et 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; Relander et al., 1994). As yet, however, the extent,
nature and rationale for secondary buy-outs and buy-ins is not wellunderstood.
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.
The first section discusses the general issues which may be expected to
influence the nature, extent and motivations for conducting a secondary buyout or buy-in. The second section outlines the methodology and data sources
used in the study. The third and fourth sections present the results, the former
dealing with quantitative evidence and the latter with the findings from the
case studies. The final section presents some conclusions.
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.
Wright et 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).
Subsidiaries may be divested as buy-outs, either where they are underperforming and/or where they are not central to the strategic direction of the
parent (Duhaime and Grant, 1984; Wright et al., 1990). However, some
subsidiaries may be divested as buy-outs because they are too small to make it
worthwhile for the parent to manage them, especially if they have few growth
prospects and/or do not have a strong market position. Buy-outs which are
relatively small in their markets may subsequently seek to become part of a
larger group in order to achieve a critical mass (Birley and Westhead, 1990;
Petty et al., 1994; Relander et al., 1994). Those with some form of strong market
position may be attractive to strategic buyers where the acquirer envisages
Secondary
buy-outs and
buy-ins
23
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24
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
buy-outs of family businesses, which tend on average to be smaller than buyouts 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.
P1d: 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.
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; Relander et 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 (Wright et 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 buyout 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 buy-outs and buyins in the fullness of time as successive equity investors need to realise
their gains.
A second managerial motivation for a secondary buy-out or buy-in may be a
requirement for more time to finish the restructuring and entrepreneurial
actions they begun at the time of the initial buy-out or buy-in, but which for
various reasons outside their control they were unable to complete in the time
Secondary
buy-outs and
buy-ins
25
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26
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 (Wright et 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., 1994). 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.
Successful companies may exit by flotation or trade sale within a three to five
year period as they are attractive to strategic partners and/or to stock market
investors (Relander et al., 1994; Bygrave et al., 1994). In making their initial
investment decisions, venture capital firms are likely to decide to invest in
those companies which they expect will meet their target rates of return within
a given time horizon (MacMillan et al., 1987; Fried and Hisrich, 1994; Wright
and Robbie, 1996). More problematical are investees where, some time after the
investment is made, it becomes clear that performance is poor or not strong
enough to make the companies attractive prospects for trade sales or flotations.
These problems may arise because of the asymmetric information inherent in
the deal screening process and may be exacerbated where investors' return
expectations depend on major restructuring (Muzyka et al., 1996). Such cases
include investees with little prospects of ever achieving growth (so-called
``living dead'' investments (Ruhnka et al., 1992)) or those with growth prospects
which have yet to be realised of portfolios. The latter have been termed ``good
rump'' investments (Wright et al., 1993) as they represent the remainder of a
venture capital firm's portfolio after the more attractive enterprises have exited.
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.
Having made an investment, venture capital firms are likely to invest time in
monitoring in an attempt to achieve their return targets (Fried and Hisrich,
1995). The intensity of this effort is likely to increase in inverse proportion to
the performance of the investment (Barry, 1994). Where a buy-out or buy-in is
under-performing, venture capitalists are likely to expend monitoring effort
and time in an attempt to rectify the situation and/or seek to find a buyer
(Relander et al., 1994). Finding a trade buyer for a more successful company
may in general be less time-consuming. A secondary buy-out or buy-in may be
identified as an exit route after this search process has failed to identify a
suitable buyer. A further dimension concerns the position of management.
Secondary
buy-outs and
buy-ins
27
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28
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 buyout 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 buyouts 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.
This stage of the analysis shows that secondary buy-outs are considerably
more prevalent than secondary buy-ins (Table I). This finding partly reflects the
greater prevalence of buy-outs rather than buy-ins. Of a sample of 229 secondary
deals identified by CMBOR, 182 (79.5 per cent) involved secondary buy-outs.
There may be changes from buy-outs to buy-ins, and vice versa, between the first
and second deals, although the most common situation is when a first buy-out
becomes a secondary buy-out. Some 86.3 per cent of secondary buy-outs were
previously a buy-out, with the balance having been first time buy-ins.
Approaching three quarters of secondary buy-ins (72.3 per cent) involved
companies which were first time buy-outs, the balance being first time buy-ins.
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.
Secondary
buy-outs and
buy-ins
29
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
Secondary buy-out
No.
Percentage
First buy-out
First buy-in
Total sample
157
25
182
Secondary buy-in
No.
Percentage
86.3
13.7
100.0
34
13
47
72.3
27.7
100.0
Total sample
No.
Percentage
191
38
229
83.4
16.6
100.0
Source: CMBOR/BZW Private Equity/Deloitte & Touche Corporate Finance
Year
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
Total
Total buy-outs
and buy-ins
Number of secondary
buy-outs and buy-ins
248
291
369
434
493
525
602
573
591
492
551
592
642
688
1
3
3
3
15
18
15
10
13
24
18
31
38
36
228
Table I.
First and secondary
buy-outs and buy-ins
Secondary buy-outs/ Percentage of
buy-ins as percentage
secondary
of all buy-outs/buy-ins
buy-outs
0.4
1.0
0.8
0.7
3.0
3.4
2.5
1.7
2.2
4.9
3.3
5.2
5.9
5.2
0.4
1.0
1.3
1.3
1.3
6.6
7.9
6.6
5.4
10.5
7.9
13.6
16.7
15.8
100.0
Note: There was one deal for which the date and other data could not be identified
Source: CMBOR/BZW Private Equity/Deloitte & Touche Corporate Finance
Table II.
Development of
secondary buy-outs
and buy-ins
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30
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 proposition P1a.
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
Value range
Table III.
Values of secondary
buy-outs and buy-ins
Less than £1m
£1m-£5m
£5m-£10m
£10m-£25m
£25m plus
Total
All
32.6
37.1
12.9
10.3
7.1
100.0
38.2
35.7
9.7
8.8
7.6
100.0
Source: CMBOR/BZW Private Equity/Deloitte & Touche Corporate Finance
Source
Table IV.
Initial deal sources of
secondary buy-outs
and buy-ins
Secondary
Receivership
Divestment
Private/family
Privatisation
Going private
Total
Secondary
All
7.3
52.6
34.5
4.7
0.9
100.0
8.1
53.9
33.3
3.8
0.9
100.0
Source: CMBOR/BZW Private Equity/Deloitte & Touche Corporate Finance
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
and P1c are 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.
Secondary
buy-outs and
buy-ins
31
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
Primary industries and energy
Food, drink and tobacco
Chemicals and man made fibres
Metals
Mechanical and instrument engineering
Electrical engineering and office machinery
Shipbuilding and vechicles
Textiles, leather, footwear
Construction, timber and furniture
Paper, printing, publishing
Other manufacturing
Transport and communication
Wholesale distribution
Retail distribution
Business, financial and other services
Total
Sample number
Secondary
All
3.5
2.7
3.1
6.9
10.4
9.3
6.9
4.6
3.1
9.3
5.8
5.0
5.4
5.6
18.5
100.0
228
1.1
3.7
2.1
4.4
8.8
8.6
3.3
4.4
6.4
6.7
6.8
5.1
8.4
5.4
24.5
100.0
6,592
Source: CMBOR/BZW Private Equity/Deloitte & Touche Corporate Finance
Table V.
Industry distributions
of secondary buy-outs
and buy-ins
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32
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 proposition P3c, that exits by secondary buyout 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 buy-out or buyin was four years old or less with a half occurring within 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
Type of exit
Table VI.
Period to exit (months)
Secondary
Trade sale
Flotation
Median
Sample
73.6
49.5
43.7
69.0
42.0
34.5
208
828
358
Source: CMBOR/BZW Private Equity/Deloitte & Touche Corporate Finance
Age at time of secondary
buy-out/buy-in (years)
Table VII.
Age at time of
secondary buy-out or
buy-in
Mean
Less than 1
1-2
2-3
3-4
4-5
5-6
6-7
7-8
8-9
9-10
At least 10
Percentage of
sample
Cumulative percentage
of sample
1.3
3.5
11.4
8.8
11.0
11.4
11.4
8.3
12.7
5.3
14.9
1.3
4.8
16.2
25.0
36.0
47.4
58.8
67.1
79.8
85.1
100.0
Note: Based on 228 companies for which data are available
Source: CMBOR/BZW Private Equity/Deloitte & Touche Corporate Finance
Company
1st deal
Year
Reason
A
B
C
D
E
F
G
H
I
J
K
L
M
MBO
MBO/I
MBO
MBO
MBO
MBO
MBO
MBO
MBO
MBO
MBO
MBO
MBO
1986
1990
1984
1990
1985
1990
1990
1986
1987
1992
1981
1988
1988
Non-core activity
Retirement
Retirement
Pending receivership
Non-core activity
Receivership
Management retired
Alternative to closure
Non-core activity
Non-core activity
Non-core activity
Group divestment
One of the owners left
2nd deal
Year
MBO
MBO
MBO
MBO
MBO
MBO
MBI
MBO
MBO
MBI
MBI
MBO
MBO
1994
1995
1989
1995
1993
1994
1994
1995
1992
1995
1995
1996
1996
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
Secondary
buy-outs and
buy-ins
33
Table VIII.
The secondary buyouts interviewed
IJEBR
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34
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 proposition P3c.
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 proposition P2a. 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
Company
A
B
C
D
E
F
G
H
I
J
K
L
M
Management
long term
reasons (P2a)
Management
transitory
reasons (P2b)
Venture
capitalists exit
timing issues
(P3b)
Failed search
for alternative
(P3c)
/
/
/
(/)
/
/
/
/
/
/
/
/
/
Table IX.
/
Rationale for secondary
Sources: Authors' interviews; / = main reason; (/) = subsidiary reason
buy-out/buy-in
(/)
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.
Experience in two further companies, where failed attempts were made to
find trade buyers' provides support for proposition P3c. Company A received
an unsolicited offer from a trade buyer which was rejected as insufficient.
Further offers were pursued, with the venture capital firm keen to achieve an
exit by this route as they were constrained by the limited life of their funds. At
Secondary
buy-outs and
buy-ins
35
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6,1
36
the same time, management expressed a desire to undertake a secondary buyout 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 buyout 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 buyout or buy-in from the point of view of venture capitalists was the need to
change management (proposition P3d). Support for this proposition was found
from the interviews, as the management teams involved in the secondary buyouts 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 second deal
It was proposed earlier that some secondary buy-outs and buy-ins were
expected to be long-term organisational forms (proposition P2a) whilst others
were likely to be transitory (proposition P2b). 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.
Of the remaining companies interviewed, four reported that they were
seeking a stock market flotation as a means of exiting from the second buy-out
and that they intended to do so within the next two to three years. Three of the
four involved companies whose second deal had a transaction value in excess
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 proposition P2b.
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 buyouts 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 buyouts and buy-ins became secondary 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 buyouts and buy-ins with particular size ranges and from particular sources.
The case studies provide support for the view that secondary buy-outs and
buy-ins are rarely considered as an initial exit route from the first deal. The
principal factors directly influencing the option to undergo a secondary
management buy-out or buy-in are as follows: a requirement in the first deal
negotiations stipulates that the venture capital firm requires an exit after a
specified period, with the secondary buy-out or buy-in being the only feasible
means of meeting this objective after other planned exit routes are delayed; the
use of a closed-end venture capital fund with a limited life. Situations where a
company requires further financing to develop products and markets where the
Secondary
buy-outs and
buy-ins
37
IJEBR
6,1
38
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 dimen
buy-outs and buy-ins
Secondary
buy-outs and
buy-ins
Mike Wright, Ken Robbie and Mark Albrighton
Centre for Management Buy-out Research, University of Nottingham,
Nottingham, UK
21
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 second buy-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 buy-outs and buy-ins and buyouts 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 and are 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; Ennew et 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; Wright et 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 (Bygrave et al., 1994; Relander et 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
Financial support for CMBOR from Deloitte & Touche and Barclays Private Equity is
gratefully acknowledged. Helpful and constructive comments from the editor and two
anonymous referees is acknowledged with thanks. The research assistance of Velda Hunter in
the case study analysis of this article is acknowledged.
International Journal of
Entrepreneurial Behaviour &
Research, Vol. 6 No. 1, 2000, pp. 21-40.
# MCB University Press, 1355-2554
IJEBR
6,1
22
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 buyout or buy-in. In 1996, secondary 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; Wright et 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; Relander et al., 1994). As yet, however, the extent,
nature and rationale for secondary buy-outs and buy-ins is not wellunderstood.
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.
The first section discusses the general issues which may be expected to
influence the nature, extent and motivations for conducting a secondary buyout or buy-in. The second section outlines the methodology and data sources
used in the study. The third and fourth sections present the results, the former
dealing with quantitative evidence and the latter with the findings from the
case studies. The final section presents some conclusions.
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.
Wright et 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).
Subsidiaries may be divested as buy-outs, either where they are underperforming and/or where they are not central to the strategic direction of the
parent (Duhaime and Grant, 1984; Wright et al., 1990). However, some
subsidiaries may be divested as buy-outs because they are too small to make it
worthwhile for the parent to manage them, especially if they have few growth
prospects and/or do not have a strong market position. Buy-outs which are
relatively small in their markets may subsequently seek to become part of a
larger group in order to achieve a critical mass (Birley and Westhead, 1990;
Petty et al., 1994; Relander et al., 1994). Those with some form of strong market
position may be attractive to strategic buyers where the acquirer envisages
Secondary
buy-outs and
buy-ins
23
IJEBR
6,1
24
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
buy-outs of family businesses, which tend on average to be smaller than buyouts 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.
P1d: 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.
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; Relander et 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 (Wright et 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 buyout 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 buy-outs and buyins in the fullness of time as successive equity investors need to realise
their gains.
A second managerial motivation for a secondary buy-out or buy-in may be a
requirement for more time to finish the restructuring and entrepreneurial
actions they begun at the time of the initial buy-out or buy-in, but which for
various reasons outside their control they were unable to complete in the time
Secondary
buy-outs and
buy-ins
25
IJEBR
6,1
26
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 (Wright et 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., 1994). 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.
Successful companies may exit by flotation or trade sale within a three to five
year period as they are attractive to strategic partners and/or to stock market
investors (Relander et al., 1994; Bygrave et al., 1994). In making their initial
investment decisions, venture capital firms are likely to decide to invest in
those companies which they expect will meet their target rates of return within
a given time horizon (MacMillan et al., 1987; Fried and Hisrich, 1994; Wright
and Robbie, 1996). More problematical are investees where, some time after the
investment is made, it becomes clear that performance is poor or not strong
enough to make the companies attractive prospects for trade sales or flotations.
These problems may arise because of the asymmetric information inherent in
the deal screening process and may be exacerbated where investors' return
expectations depend on major restructuring (Muzyka et al., 1996). Such cases
include investees with little prospects of ever achieving growth (so-called
``living dead'' investments (Ruhnka et al., 1992)) or those with growth prospects
which have yet to be realised of portfolios. The latter have been termed ``good
rump'' investments (Wright et al., 1993) as they represent the remainder of a
venture capital firm's portfolio after the more attractive enterprises have exited.
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.
Having made an investment, venture capital firms are likely to invest time in
monitoring in an attempt to achieve their return targets (Fried and Hisrich,
1995). The intensity of this effort is likely to increase in inverse proportion to
the performance of the investment (Barry, 1994). Where a buy-out or buy-in is
under-performing, venture capitalists are likely to expend monitoring effort
and time in an attempt to rectify the situation and/or seek to find a buyer
(Relander et al., 1994). Finding a trade buyer for a more successful company
may in general be less time-consuming. A secondary buy-out or buy-in may be
identified as an exit route after this search process has failed to identify a
suitable buyer. A further dimension concerns the position of management.
Secondary
buy-outs and
buy-ins
27
IJEBR
6,1
28
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 buyout 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 buyouts 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.
This stage of the analysis shows that secondary buy-outs are considerably
more prevalent than secondary buy-ins (Table I). This finding partly reflects the
greater prevalence of buy-outs rather than buy-ins. Of a sample of 229 secondary
deals identified by CMBOR, 182 (79.5 per cent) involved secondary buy-outs.
There may be changes from buy-outs to buy-ins, and vice versa, between the first
and second deals, although the most common situation is when a first buy-out
becomes a secondary buy-out. Some 86.3 per cent of secondary buy-outs were
previously a buy-out, with the balance having been first time buy-ins.
Approaching three quarters of secondary buy-ins (72.3 per cent) involved
companies which were first time buy-outs, the balance being first time buy-ins.
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.
Secondary
buy-outs and
buy-ins
29
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
Secondary buy-out
No.
Percentage
First buy-out
First buy-in
Total sample
157
25
182
Secondary buy-in
No.
Percentage
86.3
13.7
100.0
34
13
47
72.3
27.7
100.0
Total sample
No.
Percentage
191
38
229
83.4
16.6
100.0
Source: CMBOR/BZW Private Equity/Deloitte & Touche Corporate Finance
Year
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
Total
Total buy-outs
and buy-ins
Number of secondary
buy-outs and buy-ins
248
291
369
434
493
525
602
573
591
492
551
592
642
688
1
3
3
3
15
18
15
10
13
24
18
31
38
36
228
Table I.
First and secondary
buy-outs and buy-ins
Secondary buy-outs/ Percentage of
buy-ins as percentage
secondary
of all buy-outs/buy-ins
buy-outs
0.4
1.0
0.8
0.7
3.0
3.4
2.5
1.7
2.2
4.9
3.3
5.2
5.9
5.2
0.4
1.0
1.3
1.3
1.3
6.6
7.9
6.6
5.4
10.5
7.9
13.6
16.7
15.8
100.0
Note: There was one deal for which the date and other data could not be identified
Source: CMBOR/BZW Private Equity/Deloitte & Touche Corporate Finance
Table II.
Development of
secondary buy-outs
and buy-ins
IJEBR
6,1
30
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 proposition P1a.
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
Value range
Table III.
Values of secondary
buy-outs and buy-ins
Less than £1m
£1m-£5m
£5m-£10m
£10m-£25m
£25m plus
Total
All
32.6
37.1
12.9
10.3
7.1
100.0
38.2
35.7
9.7
8.8
7.6
100.0
Source: CMBOR/BZW Private Equity/Deloitte & Touche Corporate Finance
Source
Table IV.
Initial deal sources of
secondary buy-outs
and buy-ins
Secondary
Receivership
Divestment
Private/family
Privatisation
Going private
Total
Secondary
All
7.3
52.6
34.5
4.7
0.9
100.0
8.1
53.9
33.3
3.8
0.9
100.0
Source: CMBOR/BZW Private Equity/Deloitte & Touche Corporate Finance
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
and P1c are 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.
Secondary
buy-outs and
buy-ins
31
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
Primary industries and energy
Food, drink and tobacco
Chemicals and man made fibres
Metals
Mechanical and instrument engineering
Electrical engineering and office machinery
Shipbuilding and vechicles
Textiles, leather, footwear
Construction, timber and furniture
Paper, printing, publishing
Other manufacturing
Transport and communication
Wholesale distribution
Retail distribution
Business, financial and other services
Total
Sample number
Secondary
All
3.5
2.7
3.1
6.9
10.4
9.3
6.9
4.6
3.1
9.3
5.8
5.0
5.4
5.6
18.5
100.0
228
1.1
3.7
2.1
4.4
8.8
8.6
3.3
4.4
6.4
6.7
6.8
5.1
8.4
5.4
24.5
100.0
6,592
Source: CMBOR/BZW Private Equity/Deloitte & Touche Corporate Finance
Table V.
Industry distributions
of secondary buy-outs
and buy-ins
IJEBR
6,1
32
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 proposition P3c, that exits by secondary buyout 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 buy-out or buyin was four years old or less with a half occurring within 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
Type of exit
Table VI.
Period to exit (months)
Secondary
Trade sale
Flotation
Median
Sample
73.6
49.5
43.7
69.0
42.0
34.5
208
828
358
Source: CMBOR/BZW Private Equity/Deloitte & Touche Corporate Finance
Age at time of secondary
buy-out/buy-in (years)
Table VII.
Age at time of
secondary buy-out or
buy-in
Mean
Less than 1
1-2
2-3
3-4
4-5
5-6
6-7
7-8
8-9
9-10
At least 10
Percentage of
sample
Cumulative percentage
of sample
1.3
3.5
11.4
8.8
11.0
11.4
11.4
8.3
12.7
5.3
14.9
1.3
4.8
16.2
25.0
36.0
47.4
58.8
67.1
79.8
85.1
100.0
Note: Based on 228 companies for which data are available
Source: CMBOR/BZW Private Equity/Deloitte & Touche Corporate Finance
Company
1st deal
Year
Reason
A
B
C
D
E
F
G
H
I
J
K
L
M
MBO
MBO/I
MBO
MBO
MBO
MBO
MBO
MBO
MBO
MBO
MBO
MBO
MBO
1986
1990
1984
1990
1985
1990
1990
1986
1987
1992
1981
1988
1988
Non-core activity
Retirement
Retirement
Pending receivership
Non-core activity
Receivership
Management retired
Alternative to closure
Non-core activity
Non-core activity
Non-core activity
Group divestment
One of the owners left
2nd deal
Year
MBO
MBO
MBO
MBO
MBO
MBO
MBI
MBO
MBO
MBI
MBI
MBO
MBO
1994
1995
1989
1995
1993
1994
1994
1995
1992
1995
1995
1996
1996
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
Secondary
buy-outs and
buy-ins
33
Table VIII.
The secondary buyouts interviewed
IJEBR
6,1
34
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 proposition P3c.
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 proposition P2a. 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
Company
A
B
C
D
E
F
G
H
I
J
K
L
M
Management
long term
reasons (P2a)
Management
transitory
reasons (P2b)
Venture
capitalists exit
timing issues
(P3b)
Failed search
for alternative
(P3c)
/
/
/
(/)
/
/
/
/
/
/
/
/
/
Table IX.
/
Rationale for secondary
Sources: Authors' interviews; / = main reason; (/) = subsidiary reason
buy-out/buy-in
(/)
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.
Experience in two further companies, where failed attempts were made to
find trade buyers' provides support for proposition P3c. Company A received
an unsolicited offer from a trade buyer which was rejected as insufficient.
Further offers were pursued, with the venture capital firm keen to achieve an
exit by this route as they were constrained by the limited life of their funds. At
Secondary
buy-outs and
buy-ins
35
IJEBR
6,1
36
the same time, management expressed a desire to undertake a secondary buyout 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 buyout 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 buyout or buy-in from the point of view of venture capitalists was the need to
change management (proposition P3d). Support for this proposition was found
from the interviews, as the management teams involved in the secondary buyouts 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 second deal
It was proposed earlier that some secondary buy-outs and buy-ins were
expected to be long-term organisational forms (proposition P2a) whilst others
were likely to be transitory (proposition P2b). 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.
Of the remaining companies interviewed, four reported that they were
seeking a stock market flotation as a means of exiting from the second buy-out
and that they intended to do so within the next two to three years. Three of the
four involved companies whose second deal had a transaction value in excess
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 proposition P2b.
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 buyouts 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 buyouts and buy-ins became secondary 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 buyouts and buy-ins with particular size ranges and from particular sources.
The case studies provide support for the view that secondary buy-outs and
buy-ins are rarely considered as an initial exit route from the first deal. The
principal factors directly influencing the option to undergo a secondary
management buy-out or buy-in are as follows: a requirement in the first deal
negotiations stipulates that the venture capital firm requires an exit after a
specified period, with the secondary buy-out or buy-in being the only feasible
means of meeting this objective after other planned exit routes are delayed; the
use of a closed-end venture capital fund with a limited life. Situations where a
company requires further financing to develop products and markets where the
Secondary
buy-outs and
buy-ins
37
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6,1
38
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 dimen