Business owners (especially those who are operationally involved) try to ensure managers’ goals are aligned with their own. If they are aligned, the prospects for the business are much more attractive because everyone is pulling in the same direction. Ideally, everyone should have ‘skin in the game’ so that livelihoods are tied to the success of the business.
This can be accomplished through performance-based compensation, stock options, stock or stock appreciation rights but the most significant alignment comes through a management buy-out (MBO).
So how does it work?
Simply put, an MBO involves (part of) the management team acquiring all or part of the business. While this can occur in any industry or with any size business, more complex versions involve buying a division or subsidiary from the main business. Frequently the purchase occurs with a combination of equity and debt, known as a Leveraged Buyout (LBO) and the company’s assets or cash flow secures the debt. In this way, cash-strapped management teams can buy the target company financed by debt.
Why consider an MBO (or LBO)?
From a seller’s point of view:
- The buyer is well-known to them and is already familiar with the business so there are no concerns about confidentiality. The due diligence phase generally proceeds very quickly.
- In a family business, the seller will probably prefer to pass the business on to someone they know and trust so the legacy is preserved.
- Listed companies can use an MBO as a vehicle to ‘go private’ so business decisions are subjected to less scrutiny.
From the buyer’s point of view:
- The management group can earn higher financial rewards as they grow the value of the business.
- They can improve the way the business operates which leads to a more rewarding work environment.
- Risk is reduced because they are investing in an asset they know well.
Other stakeholders can benefit too. Suppliers, customers, contractors and employees prefer MBOs (compared to acquisitions by unrelated third parties) because there is continuity with a management team which understands the business operations.
Prerequisites to a successful MBO include some degree of trust between the owners and management and this is developed over time. Discussions are usually initiated and driven by the management team which senses an opportunity. The opportunity may arise from underperformance of the business and the idea that it can be improved or turned around; imminent retirement of the owners and / or dissatisfaction with the status quo.
Whatever the rationale for the MBO, planning is important. Funding the transaction, feasibility analysis, valuation, business strategy, business models, negotiation strategy, business planning, due diligence are just a few items that need to be worked out. This is where help from competent professionals is needed.
Like all transactions, MBO’s involve risk. For one thing, the seller may have better ways of realising a return but will ignore these to focus on what appears to be an ‘easier’ option. Sometimes, a management team may impair the results of the company before the deal to drive down the purchase price. Also, the buyers may not have all the resources required to run the business successfully (even though they think they do). In the case of an LBO, too much debt can be taken on. And differences can arise between the management team and external partners (such as lenders).
Appointing an advisor (for the buyer, the seller or both) is important because these decisions are not to be taken lightly and certain skills and experience are required. Plus, someone needs to be dedicated to this endeavour; people doing it part-time, will make mistakes. The advisor will help unravel a complex puzzle for which the rewards can be great for all parties.