A management buy-out (MBO) is a transaction by which the managers of a business acquire a substantial stake in, and often, effective control of, the business they have been managing. This is often achieved through financial arrangements tailored to enable individuals of relatively modest means to acquire a business.
Management buy-outs play a major role in situations where a company:
- has shareholders who may be coming up to retirement and who may wish to exit;
- is suffering from operating or cash flow problems which needs an injection of fresh capital;
- has a non-core or under-performing businesses; and
- Is prepared to sell a division or subsidiary.
There are three essential ingredients:
1. The managers themselves must demonstrate the skills and experience in all the disciplines necessary to run the business. There must be a team leader (an MBO cannot be effectively run by a committee). The team members should be ambitious risk takers prepared to invest their own capital or borrowed money in the business.
2. The business must be commercially viable. Lenders look for competency of management, the capacity to grow, competitive advantage and cash flow.
3. The vital element is a willing seller. An MBO is not possible without the consent of the seller.
An MBO must be viable in both the short and long term. Management will be required to produce hard facts and a well-researched and convincing business plan to win over lenders or other financiers. An independent valuation by a professional appraiser will likely be required. After all, business value is seldom the same as a seller’s expectation of price.
Sources for financing the management buyout:
- The managers’ own resources. Lenders will want to see financially committed buyers – i.e., they will be looking for them to put up “hurt money” (often by
recourse to second mortgages).
- Funding from VC’s. The majority of the risk capital, in the form of equity to support an MBO, may come from independent venture capital companies.
- Funding provided by the seller. Seller financing, normally in the form of loans, is common and often makes the difference between a deal that is “bankable” and one that is not.
- Bank borrowings. Probably comprising term loans secured on specific assets and overdraft facilities for working capital.
The buyers will need the help of financial, tax and legal advisers with relevant experience to deal with sale and purchase agreements, property conveyances, supply agreements, shareholder agreements, employment agreements and banking documents.
Although every MBO is unique, all of them require patience and due care to be successfully completed.