Plan a Management Buyout?

In some cases, an MBO is the best answer

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Buyout

How do I Plan a Management Buyout?

In its simplest form, a Management Buyout (MBO) involves a company's management team pooling resources to acquire all or part of the company they manage. Typically, the management team takes full control and ownership, leveraging their expertise to grow and drive the company forward. An MBO can be an attractive alternative for vendors considering a sale for several reasons: the number of potential trade buyers may be limited, vendors may be wary of approaching competitors and disclosing sensitive information, or they may strongly prefer that the company and its staff remain independent and in familiar hands. When considering an MBO, several factors must be evaluated, such as the management team's desire, credibility, and dedication to buying the company, the availability of financing, and agreement on the funding mix by all parties involved. If these conditions are met, the MBO route can provide vendors with confidence in their company's future and offer the management team a significant opportunity to benefit from its success.

Advantages of an MBO

For a company undergoing a change in ownership, a management buyout (MBO) offers several advantages to all parties involved.

Firstly, it facilitates a smooth transition of ownership. Since the new owners are already familiar with the company, there is a reduced risk of future failure. This familiarity also reassures other employees and existing clients and trading partners that it will be “business as usual.” Additionally, the internal changes and transfer of responsibilities between the vendors and management remain confidential, while any due diligence required by funders is often completed quickly.

The strength of the management team is crucial for the potential future success of the company. Funders pay close attention to the team’s skills, experience, knowledge, and credibility, as well as their plans for the company’s future. While the management team can benefit from ownership, they must transition from being employees to owners, requiring a shift in mindset from managerial to entrepreneurial. Ensuring this transition is achievable is essential for all parties involved.

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The key characteristics of a business conducive to a successful MBO include:

  • A solid track record of profitability
  • Promising future prospects without high-risk factors
  • A strong, dedicated management team with a diverse skill set
  • A vendor open to selling to the management team at a realistic price
  • A deal structure that can be funded and supported by the company’s future cash flow
 

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(Potential) Challenges of an MBO

Management buyouts (MBOs) can be complex and present various potential challenges that need to be addressed and, if possible, resolved before completion. These challenges include:

  • Assessing the Suitability of an MBO: Determining if an MBO is the best exit option is crucial. Factors to consider include the vendor’s price expectations, the business’s growth prospects, and the quality and competency of the incoming management team.

  • Incentivizing the Management Team: The management team must be motivated and aligned with the buyout goals. Their performance and dedication are essential for the transaction’s success and the business’s ongoing growth.

  • Recovering and Protecting Vendor Loans: Vendor loans often play a significant role in financing an MBO. Negotiating suitable terms, establishing realistic repayment schedules, and ensuring the business’s cash flow stability are crucial for securing the vendor’s loan recovery and protection.

  • Maintaining Reputation and Performance Post-Buyout: Preserving and enhancing the business’s reputation post-buyout is vital for sustainable success. Ownership and management changes can create uncertainty among stakeholders, including employees, customers, and suppliers. The management team must demonstrate their ability to maintain quality, meet financial objectives, and manage stakeholder concerns to ensure a smooth transition and long-term growth.

Fund

Funding a Management Buyout

 

It is uncommon for a management team to have enough funds on their own to buy the company, so external financing is typically required to meet the goals of all parties involved.

Asset Finance

Funding that enables businesses to leverage against the assets in the company, usually property, stocks or debtors, can be a very viable option to asset-rich businesses considering MBO;

High Street & Private Debt

in addition to asset finance, banks will often consider providing a cash-flow term loan, repayable over 3-5 years to assist an MBO. Private debt funds have become far more active in the market than high street lenders;

Private Equity

PE funds will focus on backing good management teams. If the growth prospects, underlying profits, team and business are strong, then financing an MBO using Private Equity is very realistic. PE funds can provide additional benefits beyond cash to help professionalise a management team, fill holes and expand the business;

Vendor Lender Notes

Often, the sellers have to help fund the transition and leave some of their consideration in the company as loan notes to be repaid over time.

Valuation & Deal Structure

A crucial aspect of an MBO transaction is determining the purchase price or valuation of the target business. The standard valuation methodologies for UK companies apply to MBOs as well. Our team, with extensive valuation experience, can provide both parties with a well-researched and evidence-based guide to fair value, explaining the rationale and scenarios in which the buyers might increase the valuation for future sale.

In addition to valuation, it is essential to consider the deal structure, including the timing of payments to the seller and any performance-related conditions tied to subsequent payments.

To Support Management, we typically assist with:

  • An outline of the future business plan and forecast
  • A detailed understanding of the company financials, including normalised working capital, normalised profit, cash and debt;
  • Up to date, fair asset values of any equipment intended to be used in asset finance arrangements;
  • Impact of any discounts that may need to be applied;
  • The company’s current debt capacity, if further debt is intended to be used as a source of funding; and
  • Anything that may impact future growth or free cash flows of the business.

The MBO Process

The key steps of a management buyout process include:

  1. An initial appraisal of the business at a high level based on understanding the company financials, market, services, people and development prospects;
  2. Understanding what the sellers are trying to accomplish and how committed the MBO team are;
  3. Assisting the MBO team in the development of their business plan and detailed financial forecast to understand growth, affordability and debt servicing capabilities in detail;
  4. Undertaking the valuation and evaluating the ideal deal structure;
  5. Detailed financial analysis conducted, including testing the forecast financial model to show the serviceability of debt and returns to potential investors;
  6. An evaluation of possible tax consequences is undertaken;
  7. Approach to funders, a small buyout may involve just one funder while in the event of larger transactions, several may handle the financing;
  8. Offers from financiers come through, and the deal terms are negotiated;
  9. The preferred financiers are selected, and due diligence starts;
  10. Legal drafting and tax consequences are appraised in detail, including any necessary communications with HMRC;
  11. Any issues from Due Diligence are raised and addressed;
  12. Completion and change of ownership takes place;
  13. We prepare the management team for their first board meeting.

An MBO can take several months, so the vendors and management team must be ready to fully commit to the transaction for that time frame. This can be challenging since the company must be run as normal and kept on track while the transaction is ongoing.

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