Is it right for me?
Management buy outs (MBOs) involve the management team purchasing all or part of a company from the current owners, sometimes with the help of external financing. When considering undertaking a MBO, it’s important to understand the management buy-out process.
Management Buy Outs are financial transactions completed by senior management teams of a company, whereby they purchase part or all of the company from the current owner(s). This type of buy-out is attractive as the team is likely to gain greater rewards through shared ownership in the company, rather than only receiving payment as salaried employees.
An MBO usually occurs when:
No matter which buy-out option is used, they all still result in new management replacing the existing owners of the company. However, there are different models that can be used, depending on the company’s circumstances.
In today’s difficult climate of raising external funding and bank finance, deals that are funded by the current owners of the Company (the Vendors) are increasingly common. This is usually done by only part of the sale price due to the Vendors being paid at Completion, with the balance being paid out over an agreed period of time when the company can afford to make the payments.
In these scenarios, the Vendors often have controls in place to protect the payments due to them by ensuring that the company is not able to spend money or undertake certain acts without the Vendors’ consent.
An alternative to a MBO is a MBI, which involves an external management team buying the company from the current Vendors, making them the new company’s management. This usually means they replace existing management in key roles.
MBI teams are sometimes referred to as ‘turnaround’ teams. They often compete with other potential purchasers which can boost the sales price for the existing Vendors.
A BIMBO is a hybrid of a MBI and a MBO, where external managers join with internal ones to buy the company from the current Vendors. This type of deal takes place where there is a gap in the management team, so additional expertise is added to the management team to drive the business forward. Often the external managers will also contribute more cash to the deal compared with the internal management team who have ‘earned’ their shares
An MBO involves the management team buying part or all of the company from the current Vendors using their own funding or funding from the Vendors, whereas an LBO raises external finance to finance the transaction.
During a LBO the value of assets such as property, plant or machinery is leveraged to borrow money to buy the company. These assets will still be able to be used by the new owners, but they’ll need to make repayments and pay interest until the loans are satisfied.
If you find that an MBO isn’t the right option for you or your business, there’s no need to worry as there are other options you can take, depending on who you are, the owner wanting to exit or employees willing to buy the company.
There are a number of options for an owner when they want to dispose of their interest, such as:
A trade sale - This is a direct sale to a third party. They are typically a competing brand in the same sector or another business in the supply train.
A family transfer - This is where a family member takes over.
External management introduction - This is where new management is brought in to take over the day-to-day running of the business, while the owner retains ownership and control. EMI Options are often used in these scenarios.
Employee buy-out - This is where the business is sold to all employees.
Stock market float - The business offers shares via an initial public offering (IPO), where the owner sells their shares and the stockholders appoint new management.
A great alternative to MBOs are employee ownership trusts (EOTs). These can be undertaken in a couple of ways:
Indirect Ownership - This is where a trust that holds shares on behalf of employees is set up. The shares can also be bought back from employees who wish to sell them.
Direct Ownership - This is where employees own shares in their own name. Shares can also be put in an employee trust and then distributed, or some shares can be owned in the employees’ own names whilst other shares are kept in the trust.
Funding an MBO can be difficult and it’s unusual for the management team to have enough cash to hand to buy the company outright. However, there are various ways funding can be acquired, such as:
Vendor loan - This leaves some of the consideration outstanding, to be paid over time.
Asset finance - This requires leveraging against the company’s assets, such as debtors, property or stock. If the business has substantial assets, these can be used as collateral for borrowing.
Private equity - This is where cash is provided by venture capitalists, hedge funds and private investors in exchange for shares, board seats, dividends, fees and varying degrees of control.
Private loans - The management team uses secured and unsecured lending to acquire the company. Secured lending involves team members providing their homes, pension plans and other non-cash assets as collateral and usually comes in the form of a bank loan, equity release mortgages or finance company loans. Good credit references are usually essential and all assets are at risk if the MBO fails.
Business loans - These are obtained from banks or finance companies depending on the track record and type of business being purchased.
When implementing an MBO, there are a few things you need to consider, such as:
Financial assessments - It’s important to understand the value of the company and any funding options available to make the transaction and transition to new ownership as simple as possible.
Legal Aspects - Understanding legalities is crucial when undertaking any transaction, let alone during a MBO. The management team should understand what legal hurdles they may need to overcome and ensure they remain compliant with all applicable rules and regulations.
Strategic planning - Thorough strategic planning should be completed to ensure the transaction runs smoothly and that plans are in place if any issues arise.
In-depth Knowledge - The existing management team has a deeper knowledge of the business operations, strengths and weaknesses of the company, compared to an external buyer. This can often make the transaction smoother and drive effective decision-making both during and after the management buy-out.
Continuity and Stability - MBOs often provide continuity in leadership, which can positively impact the transition period. This can also provide stability that maintains strong and even enhanced ongoing operations and relationships.
Faster Decision-Making - Having an internal team take over the business can ensure processes are streamlined, making it easier to complete tasks.
Knowledge of Company Culture - The management team should be familiar with the current company culture making the transition period smoother with little to no disruptions during and after the buy-out.
Financial Challenges - Securing financing can be difficult and usually results in a burden of debt.
Conflict of Interest - There may be a conflict of interest between the management teams' roles as managers and owners that could result in short-term financial gains being prioritised over the long-term sustainability of the business.
Lack of Diversification - If the management team doesn’t have a requisite depth of experience or knowledge they may lack the skills needed to run the business effectively and deliver growth.
Employee Morale Issues - A change in ownership and company culture can cause unease and uncertainty about job security for some employees.
At Legal Clarity we have an abundance of knowledge, expertise and the skills needed to help guide you through a successful management buy-out. We act as a partner and work closely with you to empower you to maximise your commercial strategy.
There’s also no need to worry if you’re not 100% certain that a Management Buy-Out is the right choice for your business, as we’ll work with you to find the right solution that truly meets your business’s needs both now and in the future.
So what are you waiting for? Get in touch with us today to see how we can help!