Planning a management buyout (MBO)

A Management Buy-Out (“MBO”) may arise whereby a business owner is looking to realise the value created through their ownership or where a group of companies want to sell a subsidiary or division of a business to the incumbent Management Team.

In both cases, the existing Management Team would have extensive knowledge and experience of running the business on a day-to-day basis and therefore could be a viable option for the shareholders to sell to them.

What is a Management Buy-Out?

In the most simplistic terms, a Management Buy-out (MBO) is where an existing Management Team within a business acquires the majority or up to 100% of the existing shareholding from the current shareholders.

The Management Team will take full control, using their expertise to drive the company forward such that they will be in a similar position in the future to realise the value they have created down the line.

Why choose to opt for the MBO route?

There are number of reasons in which a vendor may deem an MBO to be the best option available to them which includes the following:

Limited number of trade acquirers

Some niche businesses where there are few potential acquirers and where there may be a need to approach a key competitor to enable a third party sale. There may be nervousness around competitors having the knowledge of the business being for sale such that a business owner does not wish to pursue a trade disposal route with a relatively wide marketing process.

Disclosure of sensitive information

Where there are proprietary processes or ‘know-how’ that underpins the business operations and profitability, a vendor may see a full due diligence and disclosure process as too sensitive to disclose to a third party in case of any commercial damage if the disposal does not conclude.

Long handover period

A trade acquiror may require a handover period from a vendor, to integrate an acquired business into their existing operations. Circumstances may mean that this is unattractive hence an MBO may allow a seamless transition and immediate exit if the Management Team are capable at the point of a transaction.

Succession and Legacy

Value is but one measure of a successful outcome. A lot of Vendors feel great pride in the business created and great loyalty to those assisting that value creation. An MBO allows the business to continue as an independent business rather than being swallowed by a larger trade acquiror. Equally, an MBO allows the Management Team to create their own equity value in time as a reward for their hard work.

Impact of a change in ownership

Some Management Teams may be unwilling to continue in their role under new ownership. Choosing a full trade disposal process may be a ‘shock’ to certain of the key Senior Leadership Team (“SLT”) who react negatively to perceived negative change. This perception may create friction between an owner and their SLT.

Valuation and price

A key consideration of a Management Buyout is the valuation of the business and the majority shareholder will need to strike the balance of achieving the value they have created but being mindful that the Management Team will also be looking to compensate the shareholders at what they deem to be fair consideration.

An independent valuation can be produced using multiple methodologies, typically being one of the following:

• Market-based valuations
• Utilising transaction multiples in comparable markets and applying those multiples to maintainable profits to reach a valuation.
• Net asset valuations
• In some cases, it can be argued that the net assets of a business plus an appropriate level of goodwill can best represent a fair valuation.

In many cases, a valuation will be ‘set’ by the available cash generation of a business over a set time-frame. The inference here being to acknowledge that the ‘target’ business will be generating the cashflow to enable the Management Team to acquire the target business.

A fair and equitable price involves an element of judgement and ultimately this will be at a price a willing buyer can ‘fund’ and that a willing seller would ‘accept’.

Funding an MBO

In many cases, the Management Team will require finance to fund the transaction. Whilst the Management Team would be expected to utilise any existing shareholding they hold to contribute towards the price (in the form of a share rollover), there will be a ‘balance’ that needs to be funded. This can be done through the following sources of finance whether as a standalone element or as a combination:

• Asset finance
• Funding is generated by using assets in the business such as property or debtors as security. Asset finance is commonly used as part of funding an MBO.
• Debt funding
• High street banks and private debt funders can offer cash-flow term loans which are re-payable over a specified period, typically 3 – 5 years.
• Private Equity (PE)
• PE will look to fund a transaction in a business if strong growth is forecast and the Management Team are seen as a robust driving force to achieve the projected growth. PE can also assist in plugging any gaps which may be needed to assist with the expansion and growth of the business in the future.
• Vendor loan notes
• Some shareholders will look to assist in funding the transaction through leaving some of their consideration in the company and recouping interest on the loans before the capital amount is repaid at an appropriate time for the business based on future forecast cash-flows.

Legal involvement

Typically, a new company will be created by the Management Team to acquire the shares of the MBO target business. This will involve legal support including:

• Producing relevant governing documents such as the Articles of Association.
• Review of any loan / funding agreements with funders.
• Service agreements with the outgoing directors if there is an ongoing role.
• Sale and purchase agreement required to document and enact the transaction.
• Any legal due diligence required by the Management Team.