Selling your business to your employees

While it is a misconception, the idea that management buy-out (MBO) candidates need to have access to significant capital in order to buy-in has stopped people considering it as an option in the past.

Why go down the MBO path?

An MBO can be an attractive exit option for an existing business owner for many reasons, including:

High success rate: constructive and open discussions between existing owners and management regarding an MBO plan often leads to greater success levels compared to other sell down strategies like trade sale or initial public offering (IPO). Everybody knows each other, expectations are known and set early, and management’s familiarity with a business will reinforce the viability of the business with them.

Reduced costs: typically, an MBO will be a cheaper transaction than most other strategies. Reduced due diligence requirements, and the possibility of using common bankers may help.

Greater transaction flexibility: sell down transactions 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 transaction between owners, and to provide management more time to finance a buy-in.

Vendor satisfaction: most business owners spend years developing and growing a business and strong relationships and trust with managers and clients.

A successful transition of ownership to management will often leave exiting business owners feeling confident regarding the future of their hard work.

When is an MBO Feasible?

For an MBO to be feasible, there is a number of criteria which should be present. These include:

  • A strong and well-balanced management team
  • A commercially sound business on a stand-alone basis, with a history of generating consistent positive cash flows, and capable of supporting an appropriate funding structure for the MBO
  • A willing vendor and management team with realistic views regarding valuation.

Did you notice that ‘a management team with lots of money at their disposal’ was not one of the criteria?

It is not essential that management have the ability to outlay a large amount of cash to buy into a business. If structured correctly, there are a number of alternative funding structures which are affordable and will help meet the goals of the existing and future business owners.

MBO Structures and Funding

There are several strategies and funding sources which can be accessed to achieve a successful MBO including:

Vendor funding: funding from the exiting owners directly, or from the company directly. There are several 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. An employee share plan is one option for pursuing a vendor funded MBO strategy.

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 exiting shareholders) or to the management team.

Private equity: management usually partner with a private equity funder. Structures can vary and generally combine a mix of debt and equity funding.

How to Start an MBO Process?

It is important to start planning as soon as possible, particularly where a staged transaction process is preferred. Careful planning, preparing your business for transition and the early involvement of management will ensure a more successful transaction.

If you are a business owner contemplating selling contact PKF on +61 2 8346 6000 to discuss an MBO or other potential options.

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