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It’s private equity’s best-kept secret. For every buyout that makes millionaires of its management team, another ends in receivership and personal misery.

We only hear about the successes. Clearwater Corporate Finance recently boasted that it created a whopping 85 millionaires from advising 61 buyouts in three years. Barclays Private Equity claimed that the chief execs it backs pocket an average of £16m from leading £100mplus MBOs. Serial dealmakers such as Rob Templeman - who ran Homebase for Permira, Halfords for CVC Capital Partners and then Debenhams for CVC and Texas Pacific - have made massive reputations alongside their millions.

 

But before you decide to seize control of your company and make your fortune, consider this. The investment industry’s rule of thumb is that out of every ten MBOs, one will be a star, another eight will perform steadily and one unlucky venture will go under. Of the 340 buyouts that exited last year, an eye-popping 21 per cent were receiverships, according to the Centre for Management Buyout Research (CMBOR).

"Private equity is good at hiding its bad news,2 observes Alex White of BDO Stoy Hayward.

Take 150-year-old family-owned meat processing company Henry Newbould. Local business consultant Rob Clarke completed a buy-in MBO of the Teeside firm’s manufacturing business in 2004, with debt from Barclays Bank. "I did some consultancy work for the firm and realised there was tremendous scope to expand their operations, supplying supermarkets on a national level," Clarke told a local newspaper at the time.

All went to plan at first, as Clarke invested over £1m in the plant and clinched contracts with Asda, Morrisons and Somerfield. But like so many small food suppliers, Newboulds became a casualty of the supermarket price war. "There was huge pressure on margins," confirms Adrian Berry of the receivers Deloitte & Touche. By December 2005 the company was forced to call in the administrators. Like others who have led failed buyouts in recent months, Clarke could not be reached for comment. Many staff lost their jobs (although the retail arm, Naturally Newboulds, continues to trade successfully).

When Dunedin Enterprise Investment Trust sold its stake in modular building business Calsafe to quoted US group Champion in February 2006, Kevin Wheat and his partner David Turnbull became very rich men.   In early 2004 the pair had led a £37m MBO of the business from parent company Caledonian with backing from Dunedin. Just over two years later Calsafe was sold for £62m in a deal that made Dunedin 5.8 times its investment " and made the pair "a few million", according to one insider. How’d they do it? The company diversified rapidly, from prisons to hotels to Ministry of Defence accommodation. It developed the UK’s tallest modular building, a 17-storey tower on the M4. And the partners disposed of a non-core division for £14m. As a result, turnover rose from £60m to approximately £90m.

What’s so striking about the current buyout market are the extremes of success and failure on display. Many entrepreneurs and backers are selling out quickly for five or six times their initial investment. But the same cheap debt tempts some managers to borrow too much.

"We see a lot of entrepreneurs who have overpaid for their business with truly awful financial arrangements that rely on rapid growth. The borrowing is based on wildly optimistic forecasts that will overstretch their cashflow," says White.

Obviously, there are fortunes to be made. And when buyout entrepreneurs win, they usually win big. The Barclays research, in collaboration with CMBOR, found management teams on average own 31.6 per cent of MBO companies bought for between £10m and £100m, and that the average profit on exit is £36.8m, split between around five people. Not bad for a few years’ graft.

But be warned. Stories of half-forgotten divisional operations being successfully bought out and transformed into high-growth enterprises are hard to find. "The best buyout businesses are not usually the sleepy targets but the ones that are badly managed," says Malcolm Shierson of Grant Thornton’s corporate recovery team. "Many managers have an inflated sense of possibility because they are emotionally attached to the venture."

Stumbling blocks for the unaware include aggressive rivals, market downturns and poor creditors. Buyouts in the retail and consumer goods sectors have been hit especially hard. Off-licence business Unwins, led by colourful Australian banker Phillip Cook, was among many chains that went into receivership last year. North-east pub operator Wessex Taverns also slipped into administration thanks to cashflow problems, although it has since been snapped up for £20m by serial entrepreneur John Sands. And who could forget MG Rover?

For many of these business managers, the financial and personal consequences are grim. They lose their equity stake - typically one or two years’ salary - and, fairly or not, their reputation. Tales of repossessed houses and failed marriages are all too common. "Usually if a firm goes into administration they lose the lot," White says. Brands and assets, meanwhile, are more robust, and the company itself may well rise again.

So what lessons can aspiring buyout leaders take from others’ mistakes? First, get the finances and the focus right. Venture capital and private equity backers bring contacts, experience and money to the enterprise but they also want to make a lot of money quickly. To maximise their own returns they sometimes talk managers into financing the deal by borrowing, rather than selling equity to a string of different backers.

Of the 340 buyouts that exited in 2005, 74 went into receivership. Here are ten you may have heard of:   Unwins Chesterton I nternational Cox Plant Hire Chesterton I nternational Teddington Studios Wessex Taverns MVC E ntertainment Boymeetsgirl Speed Dating Hugh Mackay Carpets Henry Newbould MG Rover Source: Centre for Management Buyout Research

"A lot of these deals are leveraged at six or seven times earnings, which are themselves assumed to grow aggressively. There’s not much flexibility if things go wrong. Even a modest diversion from that rate of growth will bring the backers to the table," White says.

Think carefully before borrowing too heavily, even if financiers are willing to write the cheque. Retailers, bars and restaurant chains with big rent bills, and other businesses with high fixed costs, can be caught out by regular repayments. "Debt can be a millstone. Working like mad just to pay off the bank interest can get very wearing. There’s no point persuading the bank to lend if your projections are optimistic," advises Bruce Cartwright of PricewaterhouseCoopers.

Running out of cash is one of the most common mistakes a rookie buyout entrepreneur makes. Do rolling cashflow projections and keep a close watch on orders and sales, White says. "If you hit an iceberg you can react much more quickly if you have that discipline and rigour." Immediately after the deal make contingency plans for financial liabilities such as unexpected tax bills or legal actions.

So far, so avoidable. But what about the unforeseen events that can hit the best-prepared serial entrepreneur? Take Marcel Klepfisch. In 2001 private equity group Doughty Hanson parachuted him into the film and photo paper maker Ilford Imaging, charged with propelling the 125-year-old firm into the digital age. Klepfisch had a tough task. Consumer interest in black and white photography fell off a cliff, as expected. But demand for digital photo accessories such as memory cards and home printers did not grow as fast as forecast. "There was nothing wrong with the business plan. Had the timeframe worked, they would have made a lot of money," said one insider. With more working capital the company may have survived.

Once again, it’s often retailers, leisure ventures and other companies relying on customers coming through the door that are most likely to be hit by a curveball. DVD and CD retailer MVC Entertainment is a case in point. A group of investors led by Chris Steed of Argyll Partners bought out the loss-making company from Woolworths for £5.5m in August last year. By December the business had been put in the hands of administrators Kroll thanks to cash-flow problems caused by very tough trading conditions. Competition from supermarkets, the growing popularity of internet downloads and the long-term problem of pirate DVDs and CDs all conspired to drag the chain under.

Clients as well as rivals can cause problems for unsuspecting managers, as Dundee-based Autocare UK can attest. The company, which inspected, stored and transported new cars for the motor industry, was already struggling in an aggressively priced logistics market. The failure of MG Rover, one of its key customers, proved a fatal blow.

When Ken Savage’s business partner Paul Millard died of cancer shortly after the pair bought out car dealership Perrys, the blow was both personal and professional.   "Paul was the principal in the buyout and I was concerned stakeholders would react badly. But he was professional and he put the right structures in place," Savage says. The buyout process had began on a bad foot. The partners approached more than 20 potential backers before securing £35m of debt funding from Bank of Scotland in 2000. "Sentiment in the sector was very negative," Savage remembers. "We were caught in the ‘Rip-off Britain’ campaign. Dealers were under threat from cheap imports from the continent. And there was potential competition from supermarkets and the internet." But Millard and Savage, both with years of experience in the motor industry, were confident that the danger was overstated. And so it proved. After repairing relations with key car manufacturers, sales have grown from £259m in 2001 to £378m in 2005. Helpfully, the interest rate fell shortly after completion, giving the partners space to build the business. Today operating profits have more than doubled from £3.4m to £8.1m.

"It’s hard when a business is forced to rely on customers that are dominant and that demand set standards of quality and service. Clever entrepreneurs try to work in partnership with them. They will offer to share information on their costs and ask for advice on how to get them down," says PwC’s Cartwright, who handled the Autocare administration.

Beware also the long, gentle slide to oblivion as sales and profits at what was once a fast-growing venture start to fall. "These companies don’t get a lot of TLC from their private equity house. They miss their exit date and become unloved. For the managers they start to become a lifestyle business," says Ernst & Young’s Bloom.

Finally, seek professional help as soon as problems emerge. You are more likely to survive with your reputation intact if you engage with the problem early.

Some entrepreneurs do bounce back from failure. Unwins’ Cook is now a major investor in Ofex-listed Merchant Group, an Australian company planning to open a chain of UK cafes. "Lots of them turn up claiming to be turnaround specialists," says Bloom wryly. But clearly, buyouts are no easy route to fortune. Managers work extremely hard to turn a firm around and more MBOs will go wrong, or nowhere, than go brilliantly right.

Without risk, however, there is no reward. "Most management teams don’t get the opportunity to do an MBO," says Mike Reeves, Clearwater’s joint managing director. "If you do, then grab hold of it and run with it."

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