How Do Management Buyouts Work?4 Sep 2021
A management buyout (MBO) is a transaction in which the current management team of a business purchases the operations and assets of the company they manage. An MBO can be appealing to the buyer from the perspective of transitioning from employees to owners, thus profiting more and gaining control over the business.
These transactions can also be an attractive option to willing sellers, as in many ways, it can be cheaper and easier to sell to parties who already have intimate knowledge of the business.
How is an MBO different from an MBI?
An MBO is different from a management buy-in (MBI), in which an external management team purchases a business and replaces the current management.
The primary advantage of an MBO over an MBI is that the party acquiring the business already has first-hand knowledge of the company, thus maximising the probability of a smooth transition and ongoing business success.
A well-known management buyout example is that of Dell. In 2013, the company’s original founder, Michael Dell, paid $25 billion as part of an MBO of the company he originally founded, in order to take it private and regain more control over the business’s direction.
What is a leveraged buyout?
A leveraged buyout (LBO) is an acquisition in which a company is purchased using a combination of debt and equity, with the business's cash flow forming part of the collateral necessary to secure (and in some cases repay) the loan.
A management buyout can also be a leveraged buyout.
When is an MBO necessary?
The most common reasons that make an MBO necessary include:
The existing owner wants to exit the company
The parent company may want to divest itself of a business division or subsidiary
The management team envisions greater business success and opportunity under new ownership
The business is in distress (or has already gone into receivership), but still has solid potential
There are a variety of advantages and disadvantages to an MBO, and depending on the circumstances, it may only be one of a handful of options. For companies in trouble, however, it can become the most viable (and one of the only) alternatives to liquidation.
The process of an MBO
While it may seem to be an easier option to sell to existing management over an outside party, completing an MBO is still a complex undertaking.
Key stages and considerations include:
Deal structure and valuation
Will the buyers acquire assets only or the company's issued share capital as well? There are pros and cons to each structure, and both parties must explore each carefully. Factors to consider include:
Current asset valuations
A comprehensive analysis of the company's current financials (including profit, cash, debt, and working capital)
The company's ability to service any existing debt
Agreeing to a valuation may be a complex task and may require the engagement of an independent valuer to solve.
Understanding the tax implications
The potential tax implications of an MBO will vary depending on the particular circumstances of the transaction.
Therefore, it is imperative that parties consult with expert accountants/tax professionals to understand what taxes may be applicable, such as capital gains tax, value added tax, stamp duty, or corporation tax.
How is the transaction to be financed? The MBO team may be in a position to fund it personally; otherwise, a bank loan or private equity investment may be necessary. It could also be a combination of these. The MBO team will have to carefully consider whether they are willing to give up 100% control over the business if they choose to introduce private equity investors into the mix.
Often, bank loans form the bulk of MBO funding, and such loans require securing. If the MBO team intends to purchase the assets and share capital, the company will essentially be providing financial assistance to the MBO for the acquisition of its own shares.
This arrangement may not be problematic, but it must be carefully considered, especially if the company's solvency is in any doubt.
The process of due diligence in any asset or share acquisition can cover commercial, financial, and legal issues, so it's vital that the MBO team carefully consider how much they should exercise. While they may have a depth of knowledge of the business at an operational level, there may be many other aspects of the company to which they are not privy.
Once due diligence is completed, the negotiations regarding the legal documentation will include the topic of warranties. Warranties are often one of the most contentious issues, as the seller may be reluctant to offer warranties as part of the sale.
A common argument is that, as the MBO team has been directly involved in the business operations already, no warranty is due. It is common for the scope of warranty protections awarded through MBOs to be considerably less than would be the case with an external party sale.
Advantages of a management buyout
Relative ease of sale
For the seller, a successful management buyout allows them to avoid spending the time, effort, and money on marketing their business for sale and vetting potential buyers. MBOs, therefore, typically result in a cheaper, faster, and easier sale.
In addition, because the buyers already possess intimate, real-time knowledge of the business, the sales process is also usually much more straightforward, as far less due diligence is necessary.
Higher chance of ongoing success
Generally speaking, businesses that are purchased through an MBO (instead of an external buyer) have a greater chance of ongoing success. Understandably, this is usually due to the in-depth company knowledge that the buyers already have, allowing them to transition easily and implement any necessary changes at organisational or procedural levels with relative ease and speed. In addition, MBOs also often allow for easier maintenance of relationships with suppliers and clients who are critical to the business's success.
An MBO allows for optimal maintenance of business confidentiality throughout the sales process, as internal buyers are already privy to company information.
This not only means that clients, suppliers, and employees can maintain confidence in the company's confidentiality with clients, suppliers, and employees, but also protects the business from the risks of divulging any sensitive business details to external parties; even with a non-disclosure agreement, sharing sensitive data is never free from risk.
Disadvantages of a management buyout
A business's management team may be well versed in running the company, but in many cases, they lack the ability to raise sufficient funds for the buyout. Whether they lack personal wealth or have slim-to-no experience in raising high-level funds, many end up sourcing it from private equity firms or banks.
While this may get the MBO over the line, it often results in the new ownership carrying significant debt from the beginning, which can heighten stress and impede business performance. In addition, depending on how the funds are raised, the new owners may still end up having to answer to a third party, such as a private equity firm, which may not be what they had in mind.
Related: How To Read A Company Balance Sheet
Lack of experience in owning a business
Often, despite a management team being highly skilled at running the business at an operational level, they may lack the skills and/or experience to successfully own one.
It may be hard to decipher whether this will be the case until the MBO is completed and the new owners can stretch their legs in real-time; if they lack sufficient business-ownership skills, the cracks will begin to appear.
Managing the actual handover
Carefully handling and timing the actual management handover from the current owner to the new owner/s can be vital to maintaining optimal operations. For example, vital contacts or other business information must be systematically transferred to the new owners to avoid anything critical getting lost in the transition. It is prudent to have some agreeable handover terms drawn up by a third-party professional to avoid any unnecessary bumps in the road ahead.
Mitigating insider trading risks
Sellers must keep their eye on the ball when it comes to the risks of any underhand activities. While rare, some MBO cases involve the management team attempting to reduce the business's profitability in order to pursue a reduced purchase price.
How long does it take to complete an MBO?
MBO timeframes can vary widely, but typically take up to six months or more. The process of securing funding alone can take months to finalise. The MBO process involves working closely with a team of experts, such as accountants and legal professionals, and diligently moving through each stage to ensure an optimal transition and outcome for all.
We can help organise a successful management buyout
At Accounts and Legal, our business experts can help you plan a successful management buyout, calculate a commercial valuation, as well as ensuring you understand the factors involved in a smooth transition of business ownership.
We can help design deal structures that work for buyers, sellers, and lenders, as well as help secure funding. Our experienced tax advisors can also advise on the different tax consequences of different MBO structures for both buyers and sellers.