Management Buyouts – An Overlooked Option for Business Owners Looking to Sell

When business owners decide it’s time to sell their company, one option often overlooked is a management buyout (MBO). An MBO is when the existing management team purchases some or all of the business from the current owner. This allows the management team to take control and ownership of the company while providing an exit for the selling owner.

MBOs offer several potential benefits compared to a traditional business sale:

Smoother Transition

Selling to managers who already know the business can allow for a smoother ownership transition, rather than bringing in an outside buyer who needs to learn the operations. The current managers are already familiar with all aspects of the company. This means less disruption for employees, customers, and suppliers.

Faster Timeline

The due diligence process for an MBO can often be quicker since the management team already understands the business details. Traditional sales to outside buyers can take many months for due diligence as the buyer digs into operational and financial information they don’t already know.

Higher Valuations

While MBOs usually won’t fetch the absolute highest price possible, they can still result in strong valuations for the selling owner. The management team is incentivised to pay a fair price to make the deal work while still leaving room for profitability under their leadership.

Avoids Public Sale Process 

Selling directly to management allows the sale to happen discretely without announcing to competitors that the business is for sale. This avoids tipping off competitors who may use the news of a sale to try to poach customers, employees, or other business advantages.

Ongoing Involvement Possible

The selling owner has the option to negotiate ongoing involvement with the company under new management as a consultant, board member, or co-investor in the deal. This appeals to owners who still want to reap future financial gains from the business’s success.

While MBOs make sense on paper for many sellers, it’s not necessarily an easy path to navigate. Both sides will need to negotiate fair valuation figures acceptable to all parties involved. And assembling financing for management teams to fund the purchase can take significant planning and coordination with lenders or private investors.

Here is an in-depth look at several key considerations around executing a successful management buyout:

Structuring the Deal

The seller and management first need to agree on a reasonable valuation and payment structure for the buyout. Payment terms often involve a mix of upfront payment at closing and then deferred payments over 2-4 years tied to the future performance of the business.

Creative deal structuring options include the seller providing part of the financing through vendor loans to the management team, earning interest over time. Or the seller can maintain an equity stake and get repaid gradually as the company produces profits under new ownership.

Funding the Buyout

Management buyouts require bringing together money from different sources to fund the full purchase price. This often taps into management’s personal assets, outside private capital, and institutional financing options.

The management team will typically need to make an equity contribution investing their own capital. Lenders usually look for each executive to commit funds equal to at least one year’s salary. This ensures management is financially committing “skin in the game” while limiting personal risk to reasonable levels.

Private equity firms are a source of larger-scale capital for funding MBOs. These outside investors provide growth financing in return for partial ownership stakes and often board representation. Private equity enables putting together collected pools of capital substantial enough to buy multi-million dollar middle-market businesses.

Bank financing is needed for most buyouts to provide senior debt capital against the company’s assets and cash flows. Management partners with commercial lenders who underwrite loans based on historical finances and projections. This leverages borrowing to minimise the upfront equity requirements.

Getting lender approval requires demonstrating the company’s consistent profitability, strong cash flows, and capable leadership team to continue success. Lenders run sensitivities to ensure enough safety cushion to support debt payments if profits declined moderately.

Other specialised financing vehicles such as asset-backed lending, mezzanine debt, and seller financing can fill gaps between senior debt amounts and remaining equity needs. Creative hybrid financing stitches together capital from varied sources when pursuing complex deals.

Building the Right Team

MBO candidates need to assemble a qualified leadership team spanning the essential functional areas to execute the buyout then operate the business post-sale. This demands financial acumen plus operational expertise across sales, marketing, product development, manufacturing, and personnel management.

Lenders scrutinise the skills and experience of each executive to ensure the leadership bench strength necessary to fill the seller’s shoes. Any gaps or overreliance on the original owner raises red flags. Funding sources want a balanced team covering all the bases.

The management roster needs to demonstrate commitment to stay for the long haul after the buyout closes. Lenders get nervous about key people departing soon after the deal, risking brains drain and instability. Long-term incentives via equity ownership and retention plans help secure loyalty.

Due Diligence Requirements 

While less intensive than an outside buyer’s due diligence, lenders and equity partners on MBOs still require scrutinising details of company operations and finances. This evaluation assesses risks, validates valuation models, and uncovers red flags. Typically due diligence examines:

• Historical financial statements including sales, profits, cash flows
• Projections and growth assumptions underlying the valuation
• Customer and supplier concentrations and contract terms
• Strength of management team and personnel pipeline
• Competitive landscape and barriers to entry
• Legal and regulatory issues including IP, litigation, and compliance
• Cyber risks and information security posture

Lenders want to stress test the financials to determine whether the business can support debt repayments with reasonable profit declines. They model downside sensitivity analysis and unlikely worst-case scenarios.

This due diligence process facilitates upfront risk factor identification for the incoming management team to create risk mitigation and monitoring plans. Discovery happens while the original owner still around to weigh in with perspective and context.

Transition Planning

MBOs allow current leadership to maintain continuity, while still requiring thoughtful transition planning. Following the buyout, managers must shift mindsets from employees to owners. And they take over full accountability for stewarding the business to profitability.

A transition roadmap should cover:

• Long-range strategic planning rather than quarterly outlooks
• Revamped policies, processes, reporting structures
• Financial oversight including cash flow, banking, and taxes
• Review of vendor contracts and insurance
• Leadership development and succession planning

A glide path for the owner’s ongoing role, if any, needs definition around areas like customer relations, product strategy, and board governance. Explicit separation of past versus future areas of authority establishes clear lanes going forward.

Change management is critical even without major turnover. Employees need assurance around impacts on their roles and job security. Outbound messaging should inform key external partners of the ownership change while conveying continuity of mission and relationships.

Is MBO a Fit?

Assessing suitability upfront helps owners thoughtfully evaluate the MBO path before committing significant time and legal fees pursuing a complex transaction.

Key initial qualifying criteria include:

• Experienced management team in place with minimal gaps
• Leaders exhibit entrepreneurial ambitions and acumen
• Proven profitability history and growth prospects
• Clean business fundamentals without hidden risks
• Owner willing to carry financing if buyer can’t get full financing

For owners selling their business, exploring a management buyout option offers potential upsides compared to an outright asset sale to an outside party. MBOs reward owners for the business value they created while enabling an inside leadership team to carry the torch with minimal disruption.

Structuring and funding a buyout brings complexity. But for the right situations, an MBO can deliver an owner’s desired liquidity event and set the stage for continued success under new stewards invested literally and figuratively in the company’s next chapter.

For more information contact Ballards LLP at 01905 794 504

Disclaimer. This article has been prepared for information purposes only. Formal professional advice is strongly recommended before making decisions on the topics discussed in this release. No responsibility for any loss to any person acting, or not acting, as a result of this release can be accepted by us, or any person affiliated with us.