Brian, Karen and Steve owned a computer-based training business in Nottingham. They had built it up in the time before computers were widely used for this function and long before " dot com" mania had even been thought of.
The business was successful and profitable with a turnover of £8 million and annual after-tax profits of £700 000. The last five years had shown solid internal growth (with the signing of some strong, blue chip clients including Government departments) and they had also acquired a small competitor. The future looked bright as new products were developed, and the possibilities of computer-based training seemed unlimited.

Brian was the sales and marketing director, Karen the finance director, whilst Steve was the technical director. All were in their early 50's. They employed a stable, well-entrenched senior management team, most of whom were in their 30's and 40's; theses included Jeremy their General Manager.

One day Brian had a medical scare and his doctor advised that he should slow down. Over dinner one evening with Karen and Steve, Brian said he would love to retire and go and live in Spain and grow olives and make wine and the conversation turned to selling the business. "Well, as we started this together if you go, we all go," said Steve. "I agree, but selling a business is not as simple as that," said Karen. "Jeremy is always saying he could do a better job than we can of growing the company and has been badgering me for ages for some equity," said Brian "I'm sure he would love to own the business."

This set off a chain of events. It was agreed that the owners would investigate the disposal. It was left to Karen to do some groundwork on the sale opportunities, whilst Brian was charged with the task of confirming the strength of Jeremy's interest. Karen spoke to the company's accountant and to a Mergers and Acquisition specialist she knew. The accountant thought that it was not a good time to sell, as last year's profits had been depressed by a write off of goodwill (from the acquisition) and because the business had still to realise its full potential. The M&A man was very enthusiastic and said he knew just the right venture capitalist to support a management buyout. A company broker also said he thought there would be strong interest in a trade sale. All the experts agreed that the business was worth between £3 and £5 million. No one mentioned the need for exit strategy planning.

Meanwhile, Brian reported back to the other two that, as expected, Jeremy was very keen and had said, in effect, that if the price was right and he could get the financial backing he would like to buy the business.
During the several meetings between the owners that followed, a pattern emerged. Firstly, there was a desire to sell the business to the management whom they had all worked with for years, secondly there was a feeling that a disposal to outside parties would be too complicated and thirdly, Brian was becoming more and more anxious to sell. "Now that we have made a decision in principle " he said "I realise how stale I am and I can't wait to get out of here. June (his wife) is also very excited about going to Spain."

Events now seemed to have their own momentum. A trade sale was dismissed, because as Karen said: "We don't want every Tom, Dick and Harry to know we are selling." The opportunities of a flotation were briefly considered and then discarded as being too complicated, expensive and long-winded. The M&A man and Jeremy got on very well and Jeremy met the Venture Capitalists ("VCs") who confirmed their interest "at the right price."

This would have been the time for the owners to have taken a deep breath and thought about their exit strategy; to have carefully considered all their options and the risks involved in perusing the MBO route with Jeremy. As it was, Brian's impatience and Jeremy's pushiness propelled them forward; they seemed to lose control of their business destiny, and the MBO deal, subject to agreement on price, was accepted as being the best outcome for all.
Amazingly, despite the lack of planning by the owners, all went well for a while with the MBO. Key management indicated their desire to participate in the buyout and seemed supportive of Jeremy as CEO designate. The VC's agreed to invest subject to price, due diligence and the addition of a competent financial controller of their choosing to the management team. The company's bank was also prepared to provide support on the basis of the securities offered and personal guarantees.

Then the negotiations on price became serious and the first signs of trouble emerged. The VC said the business was worth £3 million, whilst the owners said they would not take less than £5million. There was some disagreement amongst the management team on the price and the need to provide personal guarantees and some disquiet about Jeremy's business acumen. The owners ignored these danger signs, especially when the VC's seemed willing to increase the price to £4 million and the M&A man said that the niggles amongst the management team were just last minute nerves amongst buyers, which was usual in these sorts of transactions.

Eventually, a price of £4.2 million was agreed, subject to due diligence. The owners were not entirely happy, but accepted that as it was a quick sale and the total purchase price was payable in cash, it was probably a reasonable price.

Due diligence was a nightmare for owners and managers alike. Without expert assistance the owners were bogged down in days of discussions and negotiations, whilst new problems with the business seemed to be uncovered by the VCs almost every day. Amongst these problems was that some of the major contracts (including a key Government one) were not legally enforceable and the VCs threatened to withdraw from the deal unless this was fixed. At best, they said, they would continue with the purchase, but the price would have to be adjusted downwards to £3.5 million. Compounding this problem was the fact that the blame for the contracts was laid at the feet of Jeremy and Karen (but mainly Jeremy), and serious questions began to be asked by some of the managers about Jeremy's abilities to run the company.

Fortunately, it appeared that the price problem was solved when the VC's proposed a compromise: the price would be reduced by £200 000 to £4 million and £750 000 would be retained on an "earn out" basis payable after 24 months, subject to gross revenues not falling below the average for the last three years. With some reluctance the owners accepted this offer, realising that they had come so far and that they had neglected their business for long enough during the negotiations and fearing long-term damage to the business if the deal did not go ahead. As all now seemed settled and a dinner was arranged for the owners and the management team to celebrate the apparent successful conclusion of negotiations.

At the dinner it was apparent that there was still considerable tension within the management team and words were exchanged about the personal guarantees and who was responsible for the shaky contracts. The owners tried to smooth things over and appeared to have achieved this as the dinner ended in apparent harmony.
You can imagine the owners' shock when the next morning three members of the management team announced to the owners that they were not going ahead with the deal!

From here things began to unravel. The VCs announced that they would no longer support the transaction, terrible rows and recriminations broke out amongst the management team leading to resignations from key members, in particular from the sales and marketing department. Employee morale, which was already undermined by the MBO process, now plummeted; some customers failed to renew their orders and sales fell.

The owners' relationships were never the same and Brian announced he would like to sell his shares to the other owners. Because there was no shareholders' agreement in place there was no agreement on the price to be paid by fellow shareholders for Brian's shares in these circumstances, let alone any funding in place to enable the others to buy the shares. In the event, a price could not be agreed (with Brian asking for one third of the MBO price and the other two disputing whether a minority share was worth this price and also citing the falling turnover as a reason why the price should be less), so the question of raising the funds became academic. Brian then announced that he would try to sell his shares to a third party, causing the other two owners to look at the company's Articles of Association (for the first time!) to see what rights they had to prevent this, or to refuse to register the transfer.

This, of course, is not the atmosphere in which to run a successful company. Brian could not find a buyer and, in the end, the owners all agreed to sell. The industry was by now well aware of their problems and the sales book clearly illustrated their fall from grace. After a further 10 months the business was sold to a competitor for £ 1.5 million and we never found out whether Brian went to Spain!

To an outsider it was obvious what had gone wrong. Brian, Karen and Steve had not planned for their exit and, consequently, made many mistakes in their attempts to cash in their equity. The most obvious ones were:

1. They put all their eggs in Jeremy's basket without properly assessing his strengths and weaknesses and establishing that he had firm long-term commitment from a unified management team, nor had they groomed the management team for leadership roles. They had not prepared for "plan B" if their first choice plan fell through. They had rushed at the first apparent opportunity: what had appeared to be the easy way out.
2. They had not prepared their business for sale. They had not, for instance, conducted their own due diligence in advance of the real one. If they had they would have realised that their contracts were in a mess and would have had time to rectify this impediment to sale. This would also have prevented the inherent weakness in the management team from destroying its cohesion when placed under he pressure of the due diligence revelations.
3. They had not used the services of an expert to assist them in their negotiations with the financiers. Because (like most private business owners) they lacked sales negotiating experience, this put them at a disadvantage and also distracted them from their task of running their business.
4. They had no shareholders' agreement in place to cover the circumstances that can arise when shareholders are forced to, or wish to, transfer their shares, nor any funding mechanism in place to facilitate the purchase by remaining shareholders. So, even when the MBO had failed, they were unable to heal the rifts that the failure had caused by buying Brian's shares.