Value or undervalue?

We have been involved in several management buyouts (MBOs) recently. The structure used is typical in that a new company (NewHoldCo) is set up by the managers and this acquires the shares of the existing trading company (Target) from the exiting shareholders for a consideration that usually comprises a combination of cash and loan notes.

The excess of the consideration over the trading company’s net asset value is essentially goodwill the payment for which will be met from the trading company’s future profits which will be paid by way of dividend up to NewHoldCo.

This will then be used to repay the loan notes perhaps over a five-year period. At the outset NewHoldCo will therefore be laden with the debt of the loan notes and possibly also of the bank borrowings.

Our query concerns the value of the managers’ shares in NewHoldCo. In...