Everything you need to know about management buyouts explained
Management buyouts have become increasingly common in recent years, especially in small business acquisitions. It’s something the Ledge Finance team are familiar with, having been through a management buyout ourselves, and having facilitated them for many of our clients.
In a management buyout (MBO), a company’s management team purchases the company from its current shareholders.
Because the management team is well-versed in the company’s operations, buyouts have a low risk of disruption and minimal transition and generally entail a fair selling price based on independent valuations.
Management buyouts are an ideal option for successful businesses that don’t have a clear succession plan, as it creates a smooth internal transition to those best-positioned to ensure the business’s success.
Several benefits and risks associated with management buyouts need to be considered. We explore these along with the process and funding options below.
What is a management buyout?
A management buyout (MBO) is a type of business transaction in which the existing management team of a company buys out the majority of the company’s shares from its current shareholders.
Management often use MBOs to gain complete control of a company and are often supported by debt financing and occasionally done with outside investors’ help.
Management buyout process
When approaching a management buyout, there are a few steps you should take, some of which we have summarised below.
1. Align incentives
For a management buyout to be successful, the interests of the existing management team must align with those of the shareholders. The management team should have a significant equity stake in the company to be motivated to grow the value of the business.
2. Create a detailed plan
The management team should create a detailed plan for how the buyout will be structured and financed. This plan should be shared with potential investors so that they can assess the viability of the deal.
3. Raise capital
The management team will need to raise capital from investors to finance the buyout, which can be done through equity funding or debt financing.
Equity funding is typically more expensive but allows the management team to retain control of the business.
Debt financing is generally less costly however requires security over the business to be provided to the lender which provides them with significant powers to step in should the finance fall into default.
4. Negotiate with shareholders
The management team will need to negotiate with the company’s current shareholders to buy out their equity stakes which can be a complex process often requiring external assistance to determine a fair market value.
The management team should offer a fair share price based on the valuation and other strategic benefits with all parties being prepared to negotiate the deal’s structure.
5. Close the deal
Once negotiating is complete, the management team will need to close the deal and pay for the shares through various methods, such as cash, stock, or debt. After closing the deal, the management team takes control of the company.
Management buyout funding
There are a few ways to finance a management buyout. The most common method is taking a loan from a bank or other financial institution to pay for the shares and other associated costs. The management team will then be responsible for repaying the loan.
Another option is to use debt financing from the company itself by taking out a loan against the company’s assets, such as plant & equipment, inventory, and real estate property.
This method can be advantageous as it does not require the management team to put up any personal assets or collateral. However, it can also be risky, as the company’s financial stability will be affected if the buyout is unsuccessful.
If debt financing is an option you are considering, contact your Ledge Finance Specialist, who can arrange this with a trusted financial institution on your behalf.
Another way to finance a management buyout is through equity financing. Equity financing is where the management team raises money from investors in exchange for a stake in the company. The management team can then use this money to pay for the shares.
Another option is for the management team to self-fund the buyout by using their own money or money from other sources, such as family and friends, to pay for the shares. However, this can be risky, as there is no guarantee that the buyout will be successful.
Vendor finance is a private arrangement between a buyer and a seller, wherein the buyer borrows money from a seller (otherwise known as the vendor) to help pay for the purchase/buyout of the business. It is often seen as a way of securing financing without taking out a loan from a traditional bank or finance institution or can be taken in combination with a traditional bank loan.
What are the benefits of a management buyout?
Several benefits can come from an MBO.
- It can give management more control over the direction of the company and provides access to future additional incomes via profits and dividends .
- It can give employees a greater sense of ownership and responsibility for the company’s success or failure.
- It provides a great succession plan solution for existing owners looking to exit their investment within the business often at a premium to a trade type sale or liquidation of assets .
What are the risks of a management buyout?
There may be several risks associated with MBOs.
- It can be challenging to secure acceptable financing for an MBO.
- There is always the possibility that the new management team will not be able to run the company successfully and that it will have to be sold or liquidated.
- Having a cohesive new ownership team and structure with all parties having a common understanding and agreement with the future direction of the business.
Are you about to embark on an MBO?
Frequently asked questions about management buyouts
A ‘leveraged MBO’ is when a buyout is weighted more towards debt financing than equity financing.
When approaching a management buyout, there are a few steps you should take, including aligning incentives, creating a detailed plan, raising capital, negotiating with shareholders and finally closing the deal.
Some common ways to finance a management buyout include debt financing, equity financing, self-funding, vendor finance, or a combination of all. To know more about your options, contact a Ledge Finance Specialist or contact our offices here.
Please note the information provided here is general in nature and does not constitute financial, tax or other professional advice. You should consider whether the information is appropriate for your needs and seek professional advice prior to making any decisions.