An Effective Exit Strategy?
Can a Management Buyout from an effective exit for businss owners seeking to sell?
Let’s first get the jargon out of the way:
MBO – management buyout, where (usually a small number of senior) existing employees acquire a company from its owners
MBI – similar, but a management buyin occurs where an individual or a management team not working in the target business come in from the outside and acquire it from its existing owners. Banks and funders do not tend to like MBIs, which have a significantly higher failure rate than MBOs, largely as outside people do not know ‘where the bodies are buried’, being new to the company.
BIMBO – you have guessed it, a hybrid buy in management buyout, where an internal and external team combine to acquire the business. This can bring in new skills or leadership, whilst having incumbent management that understands the business, its culture and its nuances.
VIMBO – vendor initiated management buyout, where the owner orchestrates the buyout, possibly raising the funding, deciding upon the deal structure and controlling the process.
Employee buyout – currently fashionable and offering some decent tax breaks, this necessitates an employee ownership trust to place at least 50% of the shares in the hands of the trust. This can work very well and can empower staff – but only works if senior management is competent to run the business and does not materially alter the price or ability to raise external funds to pay for the acquisition.
Share purchase – where the management team acquires the shares of the Company from the owners. This is usually via a newly formed holding company.
Asset purchase – where management does not acquire the limited company, but instead buys assets and goodwill (and will inevitably have staff TUPE* across to the newly formed company).
*TUPE stands for the Transfer of Undertakings (Protection of Employment) Regulations and its purpose is to protect employees if the business in which they are employed changes hands.
Deferred consideration – part of the payment for the acquisition of a business that is paid to the sellers over a period of time, after the sale completing. This might be conditional (ie an earn-out) or could be in the form of loan notes. Inevitably, from the perspective of a seller, a cash deal is preferred to a deal containing deferred consideration, as deferred does not have the certainty and therefore carries risk.
Hurt money – do the management team have to commit their own funds? Many (including most funders) believe that this is necessary to commit them to the process. Amounts vary according to salaries and personal wealth – very, very rough rule of thumb – assume one year’s salary for each of the MBO team.
As a process for the business owners that are selling, it is similar to a sale to an unrelated third party with hopefully similar outcomes, but for two facts: firstly, an MBO is always limited in its ability to pay as it is likely to need to raise external finance (and unlike a trade buyer, does not have any synergies that can drive earnings) and secondly, the owner may be selling to long standing employees – as a manager, you are trying to buy the business from your boss. You can imagine the implications of that one ….
There are several advantages to a company of a management buyout:
- Management know a great deal about the company so there should be a smooth transition to new ownership.
- Due diligence should be handled quickly.
- Warranties can be more limited.
- There is less scope for rumours, as the business has not been marketed to third parties for sale.
- The management team being embedded in the company can mean that customers and suppliers are relaxed and supportive of the sale.
However, it is worth also considering the drawbacks to and MBO:
- The management team will have to move from employee to owner which requires a significant change in attitude with all the risks that that entails.
- The vendor could potentially not realise the best price for the company.
- The new management team could have a conflict of interest and could downplay the future potential of the company to realise a better price for themselves.
- The whole process can be at the mercy of external funders and where the owners are pushing for best price and terms, this can cause conflict and delays.
If it is decided that an MBO is the way forward, it is usually the case that the management team will need to raise finance to fund the buyout and pay out the exiting owners. This financing can take the form of personal funding, bank debt, asset finance or private equity and very often a mix of several types of financing.
Bank funding is often sought, and banks generally like to see management financially committed to the process along with decent cash flow forecasts indicating how future capital and interest repayments will be serviced going forward.
Private equity or venture capital houses generally provide funding in return for an equity stake in the business. Private equity is not cheap and can be demanding on management teams – but private equity has also made a lot of management teams very wealthy.
The process for an MBO is much the same as any other acquisition. The usual steps to selling a company will be required ie a company valuation, detailed financial analysis, legal requirements and sale agreements will all have to be completed (see our Plan4Sale useful guide Plan4Sale Critical Tidy Up Actions (PDF) ). For the prospective new management team however, there are dual negotiations between both the vendor and the funders to consider and with two sets of different objectives to satisfy, these negotiations will need a careful mix of sensitivity and clarity of thought to achieve the best outcome. Whether acting for the sellers, or the management team (but not both at the same time!) Frazer Hall has a wealth of expertise in this area and can help with valuations, explore funding options and negotiate terms. Get in touch to discuss things further.