A Management Buyout (MBO) is a transaction in which a management team acquires a controlling stake of the company they work for, from either the parent company or from the private owners.
How does a Management Buyout work?
A management buyout is a process with multiple important steps, some of which will be required far in advance of the transaction proposal itself.
Planning
Firstly, the management team must position themselves as credible and trustworthy future owners in the eyes of the existing owner. This means doing an excellent job and communicating success clearly and effectively. Robust management reporting is extremely important here.
A successful MBO can’t happen at the wrong time, and it is important for the management team to understand and identify the right time to propose the MBO. For example, the “right time”, could be if the existing owner is approaching retirement.
The MBO should be assessed around opportunities and risks and should be paired with a detailed business plan outlining the future of the business post-sale.
Initial discussions
One of the first questions we get asked is how do managers approach the owners of the company to start initial discussions about a potential MBO?
The main thing to get out of any conversations is whether the current owners would be willing to sell. These initial talks can be delicate as the management team are often talking to their current boss!
These talks can be challenging and will have a considerable impact on the potential transaction. That’s why we recommend that you seek advice from a professional adviser to help initiate such talks.
How do you fund a Management Buyout?
There can be a misconception that a management buyout would not be feasible as the individuals of a management team often do not have large sums of cash in their bank accounts ready to invest!
It is true that a personal investment of some kind is required (a typical rule of thumb is a figure of one year’s salary) from each member of management to help fund the transaction. The personal investment is often described as ‘pain money’ to keep the management team focused on the business and committed to repaying any external debt.
However, more often than not, the majority of the total consideration is provided by third party funders including:
- Banks
- Venture capitalists
- The seller via deferred consideration.
Advantages of a Management Buyout
Opportunity for senior management
A Management Buyout presents a significant opportunity for the senior management team of a business. By acquiring a controlling stake in a business, they not only improve their potential future earnings and wealth considerably but are also given the opportunity to guide the business to further success long term.
No need to market the business for sale
When selling a business to a trade buyer, there is a lot of work involved with ensuring the transaction goes ahead. There is still plenty of work required for an MBO; however, unlike a Trade Sale, the exiting owner will not have to go to market to source a suitable third-party buyer.
Full market value of shares (generally)
Subject to negotiation, with an MBO, the exiting owner will generally receive the full market value for their shares.
Fewer potential issues (certainty of exit)
Because it means selling to people within the company, an MBO has a very high chance of being completed without complications or disruptions. With a trade sale, there is initially the challenge of finding an appropriate buyer with the appetite to make the acquisition. A Trade Sale is also dependent on a third-party acquirer who doesn’t know the business and therefore potentially more factors which may delay the closure of the deal, such as legal challenges.
Preserve the legacy of the business
A Management Buyout raises fewer questions about the long-term future of a business. Whereas a Trade Sale to a third-party buyer, such as a competitor, could usher in drastic changes to the way the business operates to both staff and customers, an MBO puts the incumbent senior management team in the position of ownership.
Performance and management continuity
The senior management team of a business will have a strong understanding of a business, its history, customer base, historical performance, culture, and staff. By transferring ownership to those who are running the business day-to-day already, an exiting owner can be more confident that the new owner knows the business inside and out.
Disadvantages of a Management Buyout
Funding and deferred consideration
For most cases, the senior management team will not have sufficient funds personally to hand to meet the valuation of the business. This means that they will need to seek additional funding from a bank or other lender and there will usually also be some element of deferred consideration (i.e., some of the purchase price is paid to the exiting shareholders over a period of time).
The business will usually take on debt
Because a Management Buyout will usually be funded by a combination of borrowing and deferred consideration, the business will be taking on debt. This debt must be taken into consideration by the management team and will impact business cash flow for the repayment period.
Price may be lower than in a Trade Sale
When a business is sold via a Management Buyout, the exiting owner is generally guaranteed the full market value of shares. However, this price may be lower than what a strategic trade buyer may offer.
Can MBO teams/private equity really compete with trade buyers?
One of the key concerns management teams have when embarking on discussions of an MBO is the worry that fundamentally they would be unable to compete with a serious trade buyer.
It is true that, in negotiations on price, a serious strategic trade buyer may have the ability to pay more for the company.
Advice for negotiating price versus a trade buyer
There are a number of strengths an MBO team has over a trade buyer in negotiations with the company’s owners. These include the following:
- Selling to management may be in the interest of the vendor; by selling to people working within the company the risk of redundancies and significant changes in corporate structures is reduced. This can often make the decision to sell by vendors easier as the business owners' legacy of the business is more likely to be protected.
- In addition, selling to the management team may give more comfort to the vendor that any deferred consideration is more secure.
- An MBO is also a great route where confidentiality is key or there is no obvious trade buyer.
- Selling to a management team also can also produce a less onerous legal position for the vendor in terms of a reduction in warranties and indemnities when compared to a trade purchaser.
How does an MBO make a return on investment?
If you’ve invested an amount of personal money into the MBO and taken on debt to help fund the transaction, you will understandably want to know how you will make a return on your investment.
A MBO traditionally delivers value over time to the equity held by the management team in two ways:
- Repayment of debt
- Increase in value
Improved profitability after MBO
Often, a motivated management team with fresh ideas can drive improved profitability. They may have ideas that have been stifled by an owner more focussed on a conservative strategy due to impending retirement. This improved profitability will directly increase the company's future valuation.
However, even if the company results remain static, just by paying back the debt used to fund the transaction, the company’s value will increase to the benefit of the management team.
The management team therefore have the potential to generate a high multiple of their initial investment on any ultimate sale. It often represents the opportunity of a lifetime.
EOT – A Management Buyout alternative?
The benefits of a Management Buyout are numerous, and for many exiting business owners, it may be the ideal exit strategy. If, however, you are unsure it is the right exit strategy, there are others which may be more suitable.
One of these is the sale of your business to an Employee Ownership Trust (EOT). There are several unique benefits of an EOT, which include the following:
- Zero capital gains tax on business sale
- Succession can be implemented over a period of time
- Tax free bonuses of up to £3,600 for employees
- Receive full market value for shares
Read more: The pros and cons of an Employee Ownership Trust
Is a Management Buyout feasible for you?
If you are still unsure on whether an MBO is feasible, or if you would like more information on the process, please contact a member of our award-winning Corporate Finance team on 0114 267 1617 who will be happy to talk things through with you. You can also contact us through our website. You may find that an MBO is more feasible that you thought.
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Adam Ames
Adam joined Shorts in 2016 following many years’ working in Corporate Finance for a large independent South Yorkshire accountancy firm and also having undertaken a senior finance role in industry working for an acquisitive Group. During his career he has gained experience and an appreciation of the many issues and opportunities faced by businesses during all market conditions and economic cycles. This experience has been used to provide invaluable advice to clients across all areas of corporate finance including MBO’s, acquisitions, disposals and finance raising assignments. Adam has in the past performed interim FD roles for clients when a robust view of trading performance and cashflow has been required. His ability to work as part of the team when performing these assignments has been greatly appreciated. Over the years Adam has built up a particular expertise in preparing forecasts for both internal and external use. He has also carried out due diligence reviews for both funders and some of South Yorkshire’s largest national and international businesses.
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