As a way of changing ownership of a business, a Management Buyout (MBO) can work well for all parties.
It’s a widely-used mechanism in many places. Management Buyouts have a lot to commend them, so it’s wise to understand the basic principles.
What is a Management Buyout?
A Management Buyout is the sale of a business to buyers led by the company’s management team.
In simple terms, the management team purchases the assets and operations of the business they manage.
But, it may not be the whole management team that participates – for many reasons. And the management team may not own the whole business after the MBO. This is usually because they need additional capital, which other parties provide.
A management team would consider a management buyout to access the greater potential rewards and control from being owners of the business rather than employees.
From the point of view of the pre-existing owner, an MBO is a way to get out of their business (an exit strategy) but leave it in the hands of people they trust. This can be important, where they feel a duty of care to their employees. They may feel the existing management are more likely to look after the staff, customers, and suppliers, than an unknown third party in a trade sale.
Of course, management may understand the business better or may also have different return on investment (ROI) criteria. So, management may offer a better price to the owners than external buyers.
Why Would Managers want a Management Buyout?
There are many motivations that managers have ahead of an MBO:
- Desire to look after a business they have been running for a period of time
- Financial reward from future growth of a business they have invested their working lives in
- Retain control against an uncertain future from a trade sale
- Smooth transition for the business (its staff, customers, and suppliers)
- Low-risk investment, if the business is sound in the run-up to the MBO (because the new owners know and understand it)
- Good investment opportunity for capital backers of the MBO team
- Relatively short and easy due diligence process, against buying a different business
How to Carry out a Management Buyout
To do this properly, a management team and the owners will each need their own professional advisors in the form of accountants and lawyers. But here are the bare bones in five chunks.
Due diligence is the process of prising up the floorboards and seeing what’s underneath. Any potential buyer needs to understand precisely what they would be buying. This means things like:
- assets and liabilities
- contractual commitments
- outstanding litigation and risks
- staff and pensions
Valuation and Negotiation
A valuation will be carried out by both the seller’s and any potential buyers’ advisors. They will usually base it on a Discounted Cash Flow (DCF) that projects different assumptions and trading scenarios forward.
These valuations will be the basis for negotiations over price and terms.
Funding the MBO
The potential buyers will need to be able to fund the purchase of the business, but also:
- Associated purchase costs, and
- Working capital, or cash flow, that they will need to operate the business
Financing the MBO
Management Buyouts usually use ‘geared financing’. That is; a mixture of equity and debt. Equity capital will come from the MBO team themselves and maybe also from some third-party backers. For small transactions, this can sometimes be family and friends. Or it may be institutional or private equity backers.
However, an MBO needs the management team members to inject a significant equity stake from their own capital. This will create suitable incentives for a long-term commitment to the business.
Debt is most often from bank loans. These are normally secured against the future earnings of the business. But, a ‘Leveraged MBO’ uses the business assets as collateral for finance.
Finally, the vendor may part-fund the Management Buyout with loan notes or by deferring part of the payment (a ‘deferred consideration’).
Staff Communication and Transition
An effective MBO is reliant on far more than the commercial transactions and high finance. It’s about communicating with staff, bringing them with the management team emotionally, and effecting a smooth transition.
One of the trickiest aspects is the transition, for the new owners, from employment to ownership: from managers to entrepreneurs.
What about MBIs and EBOs?
Let’s take them one at a time…
MBI: Management Buy-in
In a Management Buy-in, rather than the existing management buying the business, it is an external management team that buys into the business and takes over its ownership and operation. This can be pretty brutal for the pre-existing management team (and often the staff too). MBI’s are often supported by institutional investors or Private Equity firms.
EBO: Employee Buyout
An Employee Buyout extends the new ownership beyond the management team. It is a way of achieving one or both of:
- Wider (more democratic) ownership of the business
- A broader source of equity, where management cannot raise enough money
Suffice to say, EBOs are more difficult than MBOs. There is added delay and complexity in reaching an agreement with a larger group of people – many of whom have more to learn, at the outset. And there will be a need for creating ownership, management, and governance provisions that are more sophisticated and complex – and need to suit a more varied set of stakeholders.
What is Your experience of Management Buyouts?
We’d love to hear your experiences, ideas, and questions. Please leave them in the comments below.