Business exit strategies - Management Buy-Outs
Often overlooked as a viable exit option for business owners, a management buy-out (“MBO”) is a process whereby a company’s management team acquire the company from its current owners.
In my experience, MBOs are often overlooked by business owners due to the misconception that MBO candidates need to have access to significant capital in order to ‘buy-in’. In this article I take a look at how MBOs can be used as a viable exit strategy even where MBO candidates have little access to capital.
Benefits of MBOs
First of all, I would like to take a look at some of the advantages that MBOs offer. This list below is not exhaustive but I believe that the main point for business owners to take away is that while an MBO can provide a smooth, flexible and quick transaction, probably more importantly, an MBO will often leave the exiting owners feeling content in the knowledge that their business will be left in good hands.
- Confidentiality: where there are issues that are commercially sensitive, current business owners may not wish to allow competitors access to the business. An MBO process keeps this information internal to the business.
- Speed: buy-outs can be very quick to complete when all parties co-operate.
- Reduced costs: typically, compared to other types of sell down strategies, an MBO will be a cheaper transaction. Reduced due diligence requirements, and the possibility of using common bankers may help in this regard.
- High chance of success: by having constructive and open discussions between existing owners and management regarding an MBO plan, once pursued, MBO transactions typically have a higher level of success when compared to other types of sell down strategies, such as a trade sale or IPO. All parties know each other, expectations are known and set early, and management’s familiarity with the business will generally provide them with less uncertainty regarding the viability of the business.
- Flexibility: most other sale structures usually involve an all-or-nothing approach. MBOs can provide an opportunity to ‘stage’ a transaction, allowing existing owners to realise a liquidity event earlier than would otherwise be available, provide a gradual sale of the business between owners, and to provide management more time to finance a buy-in.
- Continuity & vendor satisfaction: in many cases, business owners have not only spent many years developing and growing their businesses, but have also established strong relationships and trust with existing management and customers. A successful transition of ownership to management will often leave exiting business owners feeling confident regarding the future of their hard work. Management’s detailed knowledge of the business means that an MBO offer will often be seen by a vendor as more credible than other competing offers.
It is important to start planning for an MBO as soon as possible, particularly where a staged transaction process in preferred. Careful planning, preparing the business for transition and early involvement of management will greatly improve the chances of a successful MBO transaction.
The following stages are typically in an MBO transaction:
Step 1 – Feasibility assessment:
It is important to understand early on, whether or not the business meets the criteria for a successful MBO. In our experience, the following issues should be considered:
Does the business have an experienced and well-balanced management team which is capable of running the business without continued assistance of the vendor? More importantly, is there a person who is capable of leading the business going forward?
- Is the business commercially sound with a history of generating consistent positive cash flows, and capable of supporting an appropriate funding structure for the MBO?
- Is there a willing vendor and management team, with realistic views regarding valuation? Vendors should not be afraid to have open and frank discussions with management as early as possible.
- Does the business exhibit strong growth prospects?
We strongly encourage business owners to engage the services of experienced financial advisors early on in an MBO process who will be able to assist in the development of a strategy for undertaking this feasibility assessment, particularly in relation to discussions with management.
Step 2 – Preparation of a business plan or information memorandum (“IM”):
The preparation of a document that sets out management’s strategy, details of the business, financial performance, position, prospects and competitive position is an important element in the funding process as it acts as a buy-out proposition, and can help to maximise interest from potential founders and optimise funding terms and costs.
If external funding is not required, an IM will still be useful for presentation to the proposed MBO team and will provide guidance for their own advisors. Whilst not strictly necessary, a well prepared IM will assist with a smooth MBO process and will reduce overall costs in the long run.
Step 3 – Financial structuring and tax planning:
Once the value of the business has been assessed or agreed, the proposed capital structure will determine the cost of equity for incoming investors (management and/or private equity).
A key element in finalising the financial structure is determining the amount that will be invested by the management team. This will be a function of the proposed debt and third party (private equity) capital investments.
Advice should be obtained to understand the taxation implications of alternate transaction structures such as a share or asset sale and deferred consideration. Further information regarding MBO funding options is set out below.
Step 4 – Capital raising:
Where external funding is being sought, the MBO team and their advisers will present the business plan and/or IM to financial institutions, and/or private equity investors. Expressions of interest and indicative term sheets will be sought from potential investors and/or debt funders.
The MBO team will work closely with the capital provider, as their business partner, to grow the business. Various considerations in selecting a capital partner include:
- experience in similar transactions;
- alignment of business and financial objectives; and
- cultural and personality fit with the MBO team.
Step 5 – Vendor negotiations:
Once indicative offers have been received, negotiation can commence and key issues resolved. It is preferable for negotiations to be led by the MBO advisor to ensure that a good relationship between the MBO team and the vendor is maintained.
Once key terms have been agreed, a non-binding Heads of Agreements is entered into between the MBO team and the vendor. At this point, it is also recommended that careful consideration be given to the drafting of the shareholders agreement – a number of sensitive issues will often arise during the drafting of this agreement so it will be important to start discussion this matter as early as possible.
Step 6 – Due diligence:
Institutional investors and lenders will usually undertake some form of due diligence. The object of this process is to confirm their understanding of the current state and potential of the business, assess key value drivers and risks, forecast financial performance and long term growth prospects.
Vendors should be well prepared with due diligence files ready with all relevant financial, commercial and legal information.
Step 7 – Completion and post completion:
At completion, the MBO team and other external funders will make their equity subscriptions into the business, intra-group loans will be made, the bank(s) will provide their finance and the acquisition of the business will complete.
The final stage of the MBO process is the period after completion during which relevant statutory filings are made at the relevant registries, documents to effect a transfer of title to assets are stamped are filed and changes to title to assets have been communicated to relevant registries.
Financing a MBO
It is not essential that management have large amounts of capital available to invest in a business, but they should ideally have “skin in the game”. There are a number of funding sources and structures which can be accessed to achieve a successful MBO such as:
- Vendor funding: funding from either the exiting owners directly, or from the company. There are a number of structures which can be put in place under this option and they work particularly well where existing owners want to pursue a staged exit over a period of time, including properly structured employee share ownership plans (“ESOPs”).
- Bank funding: depending on the existing level of debt of the business, a large portion of the buy-in value could be funded via bank debt. This debt could either be in the form of loans directly to the company (which then on-lends to the management team to acquire equity from the existing shareholders) or to the management team themselves.
- Private equity: in this scenario, management will usually partner with a private equity funder (specialist private equity investment firms or high net wealth individuals and families). Funding structures employing the use of private equity funding can vary and will usually combine a mix of debt and equity funding. A significant benefit of utilising private equity funding is the potential access to an experienced external management team.
If planned and executed correctly, a MBO is an efficient, lower-risk strategy for a business exit. MBOs also provide the potential to deliver significant financial benefits and satisfaction for often long serving employees.
For business owners and management, it is critical that experienced advisors are engaged to support the transaction and offer advice along the way. The involvement of advisors will also enable management to remain focused on the operations of the business during the transaction process.
Originally posted on NickNavarra.com.au