A management buy out (MBO) is a form of business exit whereby the business owner sells the company assets and operations to the existing management team.
Often a management buy out is looked on more favourably within the business than alternative forms of exit, such as trade sales, because an MBO has the potential to provide continuity for the company, its workforce and its customers.
However, the implications of an MBO are far-reaching and complex, requiring detailed consideration by all parties in the context of the company’s wider commercial aims.
Advantages of a Management Buy Out
An MBO offers a number of potential positives for a business’s stakeholders.
For the management team, taking part in the MBO can offer a number of benefits such as gaining part ownership of the business; potential enhanced return on investment; professional advancement; and improved job security.
Through an MBO, the business owner may be able to exert more control over the conditions of the sale than if they were selling to an external party, and may also value the assurance of knowing who will be taking over the running of their former business.
An MBO can generally take less time than a trade sale, provided there is agreement among parties. As negotiations are carried out between the business owner and the existing management team, sensitive and valuable business information can be kept within the business. There may also be greater potential for a smooth transition of ownership from the existing owner of the business to the management team due to continuity of strategy, operations and personnel.
The company’s employees, customers and suppliers are also more likely to respond positively to an MBO than an external party coming in, with a greater sense of certainty and assurance in respect of continued operations.
Finally, an MBO may also in many circumstances be the only option for an exit, for example where there are no other interested parties.
Disadvantages of a Management Buy Out
A key consideration for the existing owner will be price. The price paid for the business in an MBO is usually lower than that paid by a trade buyer, largely for the reasons discussed above.
In addition, as the management team will be required to invest their own money, they may find it difficult to raise sufficient funds for the MBO from their personal means, which may lead to delays or even prevent the transaction from proceeding.
An MBO may also raise questions about the skills, capability and experience of the management team to take over the business and deliver future success.
A final concern may be the risk that where an MBO fails, relations between the owner and the management may be damaged as a result.
How to approach a Management Buy Out Opportunity
Be clear on the proposition
The preliminary period of an MBO process requires all parties to gather the necessary information to form the basis of an informed decision as to whether an MBO is the right option for the business and for them personally.
Factors to consider include:
- How an MBO will affect the business, at the time of the sale and going forward, considering details such as:
- Is the business profitable? How long has it been profitable? Has this been consistent?
- Going forward, does the business have good prospects for continued profitability and growth?
- How an MBO will affect all involved personally, financially and professionally
- Does the management team have sufficient commitment and expertise to own and run the business?
- How will you fund your share? Will you need to borrow, where will you borrow from and what will the repayment terms look like?
- Whether you are comfortable with the level of risk involved in the MBO to you financially, professionally and personally?
Agree terms with the business owner
What is the market valuation of the business, taking into account:
- cash flow
- revenue and profits
- business premises
- intellectual property
- customer goodwill
- any other assets
Beyond the valuation of the business, negotiations with the business owner should include all other terms of the sale, for instance, whether certain assets are included in the sale, how payment will be made to the business owner and a timescale for the sale.
Prepare a business plan
The management team should prepare a business plan to demonstrate their commitment to the business, their understanding of it, and their vision for the business’ future.
The business plan can be used to raise funds and communicate to the business owner your plans for the future of the business.
The business plan should include elements such as:
- Executive summary – brief description of the business, reason for the MBO, and key strengths of the business
- Brief history of the business
- Description of products or services
- Details of the management team
- The business’ main customers and suppliers
- Market analysis
- Key competitors
- Business premises
- Business systems
- Strategy for growth
- Financial analysis for the last 3 years
- Specific and credible business projections for the next 5 years, supported by the related assumptions
- Any risk areas and how these risks can be combatted
It may be that you have sufficient personal funds to fund your share (expect this to be at the level of around one year’s salary). Where additional funding is required, you may consider funding options such as:
- Asset finance – raising funds against the assets of the business, such as property.
- Bank loan – although this may only be provided alongside the asset finance option above.
- Private equity – investment from private individuals or organisations in return for shares in the business.
- Vendor loan note – where the business owner helps by retaining some equity in the company that is repaid over time.
Regardless of your level of insight or knowledge of the business, carrying out formal due diligence on the business is best practice and will almost certainly be required to satisfy any funding providers.
For the purpose of due diligence, information on the following should be made available:
- business accounts
- financial projections
- valuation of property and assets owned by the business
- legal and tax compliance
- customer contracts
- intellectual property protection
- any pending legal actions against the business
At this point of the process, where the business owner and the management team have reached a final agreement and funding has been obtained, formal documentation should be drawn up by your legal advisers setting out the complete terms of the sale, to be signed by all parties to the transaction. Funds will be transferred and the MBO is complete. The management team now own the business.
Why take legal advice?
Management buy outs are generally complex transactions, requiring detailed planning and preparation and guidance through the negotiation and transaction process. If you are exploring the option of an MBO, take advice from an experienced legal adviser to help guide you through the process to successful completion.