Digital entrepreneurs: do you know what an OBO is?
Nice post from my partner Pierre Martini in charge of ISAI’s Capital Development / LBO fund. To read even if you do not look like the founders of Hospimedia!
The recent announcement of the (beautiful) exit of our Lille company, Hospimedia, from our development capital / LBO fund prompts me to write this plea in favor of a tool still little known to entrepreneurs in the digital world: the OBO or Owner Buy-Out.
Obviously, those who have always had the only prism or desire to make an industrial transfer type exit will wonder about the interest of such a mechanism. However, for hundreds of others, OBO, if it were better known and mastered, could constitute a remarkable step in their entrepreneurial journey.
To begin with, let us recall what are the foundations of a so-called OBO transaction.
An OBO is a form derived from the familiar LBO (Leveraged Buy-Out). It consists in buying back, via a takeover holding company, the whole of a company by using i) a contribution (or roll-over), partial or total, of those who want to stay in the adventure (and in particular the founders- managers) ii) little or no dilutive leverage (bank debt, mezzanine debt, etc.) and iii) additional equity capital provided by a new financial investor (the sponsor).
It is easy to understand that by playing on the various parameters, the OBO makes it possible to satisfy a wide variety of objectives:
To trace the capital of the founders-managers who may have been very diluted in the past following various rounds of venture capital. Where appropriate, the OBO is the perfect tool for founders-managers who wish to take over the majority of the company they founded.
Allow founders-managers to realize part of their capital (cash-out) within a company which may have become (too?) Important in their personal assets. I must insist on the fact that a partial capitalistic realization can, contrary to popular belief, prove to be very beneficial for entrepreneurs who thus renew their capacity sometimes a little lost over the years to take risks.
“Aerate” the round tables and organize a rotation of capital by allowing historical business angels or venture capital funds to exit on good financial terms (often without guarantee of assets and liabilities, or at least without sequestered cash; understandably …).
And, of course, this is a unique opportunity for non-founding executives to acquire a stake in the company that they are now helping to develop, and therefore to be fully involved in the creation of future value.
But, more than anything, an OBO is an opportunity to review the strategy and define a 4 or 5 year growth project, around which the different stakeholders will be aligned.
Last but not least, an OBO is often accompanied by a management package set up by the sponsor and the objective of which is to offer an excess return on capital to the founders and managers in the event of the operation’s outperformance. To illustrate my point, an LBO fund like the one I manage is looking for returns lower (typically 2.5-3x) than those of my venture capital colleagues (10x): management packages can therefore prove to be very attractive for managers, who are more likely to reach this area of superformance …
A question that often comes up: “who is the OBO for?”.
Before tackling the obvious financial questions, the first is to know if the founders-directors and the management team are real promoters of such an initiative: they must be deeply convinced that there is still a lot of value in create within the framework of a 4 or 5 year project, that it is not the right time to sell (even if some shareholders express a need to exit), express a strong ambition and a desire to explore avenues of growth little or not exploited to date (international or growth by acquisition for example).
And for a certain typology of founders-managers who have never had professional investors in their capital, bringing in a fund like the one I manage can make a real difference in the history of the company on key subjects such as structuring, assistance with external growth or, to name just one more, the management of the exit process combined with optimized valuation.
Once this step has been completed, it is obviously necessary to wonder about the company’s eligibility for an OBO. The literature on LBOs teaches that the business must be stable and recurring to generate predictable and relatively large cash flows. The L for Leveraged reminds us that we must repay the debt …
These criteria must obviously be respected to carry out an OBO, but in reality, some may prove to be incompatible with our rather volatile digital market.
At ISAI, we have carried out an intense work of reflection and adaptation of LBO practices to the specificities of digital, so as to allow pure-player companies in strong growth to execute OBOs, without these companies necessarily being extremely profitable. One of the key ideas lies around the fact that the leverage effect of an OBO in digital can and must be structured differently from that of a traditional LBO. In other words, the value comes from growth and not from leverage: you have to be able to react very quickly, and to be able to invest in the event of rapid changes in the market in which you operate. For this, it is necessarily necessary to consider lower leverage effects that draw little on the cash flow of the company (for example by using mezzanine debt in fine vs. senior amortizable debt).
Let my words not be over-interpreted: all digital companies are not made for a “growth” OBO. However, it is certain that this tool would benefit from being better known by our ecosystem.
At ISAI, around half of our development capital / LBO fund operations are devoted to growth OBOs. This was notably the case for Hospimedia. It is indisputable that this OBO has enabled this small pure-player to build a great story of growth, and to prepare for a strategic exit that would have been difficult to imagine a few years ago. The experience and backing of a professional fund, its expertise in corporate finance matters and, for ISAI, its unique expertise in the digital world through its 130 entrepreneur-underwriters, can make the difference.
In short, the OBO may not be right for you – but it’s still worth taking the time to think about it.
To contact me: [email protected]
Jean-David Chamboredon is the CEO of ISAI and co-president of France Digitale.
Pierre Martini is Managing Director of ISAI, in charge of development capital / LBO activity.