If you own a business and are thinking of selling, maybe to retire or move on to a new project, your exit strategy will be a prime consideration. And, with a recession looming, you may be considering buyers closer to home rather than an open market sale. If so, a management buy out can be a great option, since the transaction and transition to new owners who already work in the business can be a lot easier and smoother than a sale to an outsider. In addition, since the culture of the existing business is preserved and existing talent retained, they’re a great option for entrepreneurs who would prefer their business to remain intact after they leave.
Management buy outs or MBOs involve the sale of an existing business to its management team, generally funded by external finance such bank loans (secured against the company as well as to the new owners personally, as private equity or by the existing owners retaining some ownership. MBOs became extremely popular in the 1980s when the market was depressed and buyers were scarce. Since MBO transactions tend to be more straightforward than an open market sale, they can be safer and less costly to implement.
In this article, we look at the MBO in more detail, in particular, what makes a successful MBO process.
What exactly is an MBO?
An MBO is where a company is sold to its existing management team. They usually buy the shares or sometimes just the assets of the company they manage. The managers can benefit because of the potential upsides of owning a company rather than being an employee. And the seller can benefit because the transaction is generally easier to complete.
MBOs can also transform a business, since the new owners know it well and can streamline operations, leading to increased profitability by using their insider knowledge and expertise.
If you’re a seller looking to exit, MBOs can be a great option, especially where there are a limited number of potential buyers. In addition, some sellers may want the company’s know-how and confidential information to stay within the business rather than be sold on to a competitor.
An MBO is generally financed by external funders so if you’re thinking of an MBO, so as a buyer you’ll need to have the cash lined up in advance. Lenders usually require the new owners to have some ‘skin in the game’ which sees the new owners using personal savings or taking out personal loans to partially fund their ‘stake’.
What are the benefits of an MBO?
Potential lenders such as banks and private equity firms generally consider MBOs as a good investment opportunity, since they’ll benefit from the insider knowledge and expertise of the management team. For that reason, funding the purchase may be simpler than an open market acquisition, and sellers are more likely to receive a good price for the company.
An MBO ensures business continuity, with existing employees remaining in post, and critical supplier and customer relationships maintained. The due diligence process is likely to be streamlined too since the management team will have access to all the necessary information about the business.
What’s involved in the MBO process?
An MBO occurs when a corporate management team takes over the business they manage from the owner. They usually accomplish this by setting up their own new company which then borrows funds from a bank, and they may also give up a share in the company’s equity too, for example where funding comes from private equity. Typical sources of funding are private equity, banks and sometimes loan notes payable to the seller.
Once a management team has decided that they’d like to consider an MBO, they’ll need to start planning how to run the company post-sale, and how they intend to finance it. They’ll need to put together a business plan, work out what price they wish to pay, and figure out a strategy for taking the company forward. They may find themselves at odds with the seller in terms of the company valuation, so should be prepared to back up their price if the seller’s ask seems over-ambitious. This may to an extent be influenced by the valuer a funder (bank or venture capital) puts on the business.
When their preparation is complete, the team will approach the seller with an offer to buy the company. This can be done on a formal or informal basis, but it’s advisable to describe the terms they envisage to gauge the seller’s interest in a prospective sale. Alternatively, the management team may be approached by the owner with a view to a potential sale.
The next step is to raise funding for the purchase by approaching selected banks and finance houses and making a pitch. Once funding is secured, the team and the finance partner will carry out due diligence on the business to ensure that all the risks and potential liabilities are fully understood.
Following due diligence, the buyers and the legal team will draft and negotiate the purchase agreement and related documents necessary to complete the purchase.
How to plan for an MBO
Here are some of the key factors that need to be considered by the seller when planning for an MBO:
- How to prepare your business for sale. Since the issue of the company’s value is key, you’ll need to figure out what will be included in the sale. If you’d like to take some value out of the business pre-sale, such as transferring land or receiving cash as dividends, now’s the time to do it
- Decide whether the sale will be of the company’s shares, or of assets. Decide how and who will carry out the valuation. Selling the shares hands over a more complete business to the buyer.
- If you plan to be involved in the transaction, you should think about selecting the members of your management team that you’d prefer to take things over. You may negotiate with them changes to their employment terms pre-sale, or review their share option arrangements
- Make sure your tax and regulatory matters are up-to-date, and all your papers are in order, ready for due diligence
- Brief your advisors, financial and legal, well in advance of the transaction so that they can help you get ready
- Work out a personal plan for transitioning the business to the new team, including factoring in your involvement, if any
If you’re a buyer, these are some further issues to consider:
- How will you finance the transaction, and what will be your preferred terms. Are you intending to borrow (personally, in addition to as a company) and/or to issue shares to the funders?
- What roles will the management team play (and even the seller) in the business once they’ve bought it
- What’s your business strategy and business plan
- What terms will the seller be looking for, and are they acceptable to the management team
- Your view of the company’s value
What makes a successful MBO process?
One hallmark of a successful MBO is for the management team to be fully involved in the sale transaction and to transition the business to the new structure as soon as possible, ideally pre-sale. In practical terms, this means that all operations essential to the business function such as the sales process, customer relations and business operations should be handed over to the new team leaders. As well as helping to ensure a smooth transition, this will help ensure that your funders are confident in your ability to run the business successfully post transaction.
In addition to team functions, make sure your top leadership team is in place, including a nominated CEO. While this can be contentious, this should be decided pre-sale for obvious reasons. In addition, and as a top team, agree on the proposed strategy for the business, including timescales, and make sure these milestones are acceptable to funders.
Make sure that you have experienced advisors on board to guide you through the transaction. Seasoned lawyers will be familiar with the technicalities of the MBO process, and help you avoid the most common mistakes, such as taking on too much debt or agreeing to unreasonable or unachievable terms.
Consider how the company will be run in the future, and whether you need to make changes to employee terms to involve them in the company’s future success, such as introducing an employee share scheme. Consider involving employees early on, so that they feel part of the transaction and prepared to take on the new challenge ahead.
Is an MBO a right fit for your business?
If you are looking to sell your company or reduce your ownership in your company, here are some indicators that an MBO might be a good fit for you:
- The economy is slowing down or in recession, and you’re not confident that you can achieve the price you’d like for your business on the open market, or find an appropriate buyer
- You’re approaching retirement and would like to step back from day-to-day operations or exit entirely
- You have a strong and ambitious management team who have the necessary skills and appetite to become business owners
- You can see potential for your business to grow, but it needs an injection of capital or new talent to take it to the next level
It’s also important to be clear about your objectives, and how they may fit with an MBO. Do you want to remain involved in the business, and if so, for how long? Do you intend to remain active in management, or simply continue to retain shares?
Some factors are common to successful MBOs, so if your business is a good fit, then an MBO may be right for you:
- Your business is profitable, with a bright future and no immediate risks
- You have a strong management team across a variety of disciplines
- You are keen to sell and are prepared to accept a realistic price
- Your business will generate sufficient cash to meet the needs of funders
To find out more about Management Buy-Ins and Buy-In Management Buy-Outs (MBIs and BIMBOs), we've created a useful FAQ guide explaining the difference and benefits of each. We've also created a more in-depth guide about the MBO process, including the advantages/disadvantages and how they can be funded. For more answers to commonly asked questions about company sales, consult our corporate solicitors. Get in touch on 0800 689 1700, email us at firstname.lastname@example.org, or fill out the short form below with your enquiry.