Management buyouts – what they are and how to finance them

What is a management buyout?MBOs, or management buyouts, are suitable for a variety of industries, including turning employees into entrepreneurs, monetising owners’ shares, spinning off departments from their parent companies, or turning publicly traded businesses into privately held ones.

Management buyouts are typically driven by a shared vision among the management team, who believe they possess the knowledge, skills, and experience necessary to lead the company to new heights.

The process involves careful valuation, securing financing, negotiating with current owners or shareholders, conducting due diligence, and finalizing legal documentation.

By executing a management buyout, the management team assumes a significant level of responsibility and accountability for the company’s future, creating an opportunity for growth and transformation.

What is a management buyout?

Management buyouts involve existing management team members purchasing a company with external financing. A business is usually managed and owned by the management team after the old owners have retired or moved on to something else.

MBOs are commonly motivated by the following reasons:

  • There is an intention to exit the business by the old owners.
  • Divestment is the process through which a parent company sells a subsidiary or a business division.
  • Despite being in distress or being in receivership, the company still has potential.
  • There is a greater sense of opportunity under new ownership, according to the management team.

A MBO is an alternative to liquidation, selling, merging, or transferring a business when it is going through a change of ownership. Owners wishing to sell may find the MBO more beneficial than a trade sale for several reasons: It eliminates the time-consuming task of finding a trade buyer. No sensitive or proprietary information needs to be disclosed to competitors. There is no need for them to worry about the company. An emotional attachment to the business can be important for a seller.

An MBO allows managers to become owners of a business they know and understand. By doing this, you eliminate the uncertainty associated with a start-up and the risk associated with buying a company that you do not know very well.

How does an MBO work?

It usually takes up to six months to complete an MBO. Funders, lenders, and equity investors may also be required to participate, as well as lawyers, analysts, and accountants.

This is how an MBO works, right from the start to the very end.

  • The owner wishes to sell all or a part of their business venture.
  • Members of the existing management team – C suite, board seats, employees – decide to purchase the company.
  • The buyer and seller then agree on the sale price. This may require an independent valuation.
  • Amounts that can be invested are assessed by the management team. This sum comes from their personal assets and typically, it is only part of the sale price. Further funding is usually required.
  • An in-depth financial analysis is conducted. An investor’s potential returns are predicted by creating a forecast financial model.
  • Funders are approached by the buyout team. It may involve one funder or a syndicate of funders, depending on the size of the transaction.
  • To complete the sale, funders provide the cash.
  • The transaction is closed.
  • Business ownership is transferred to the buyout team.

The most difficult step in the management buyout process is financing. MBOs can be funded in a variety of ways, including cash, debt, and/or equity. Your MBO can be successfully completed with Swoop’s funding resources.

What are the advantages?

  • In-depth Industry Knowledge and Experience: The existing management team possesses deep knowledge and experience within the industry and the company itself. This expertise allows them to make informed decisions, capitalize on market opportunities, and navigate industry-specific challenges effectively.
  • Continuity and Stability: With a management buyout, there is often a smooth transition of leadership and continuity of the company’s operations. This stability helps maintain employee morale, customer relationships, and supplier confidence, reducing potential disruptions that can occur with external ownership changes.
  • Alignment of Interests: In a management buyout, the management team becomes both owners and decision-makers, aligning their interests with the success of the company. This alignment fosters a strong sense of commitment, motivation, and accountability among the management team, leading to enhanced performance and dedication to achieving long-term goals.
  • Flexibility and Agility: As owners, the management team has the flexibility to make strategic decisions quickly and implement changes without the need for extensive approvals or bureaucracy. This agility enables them to respond rapidly to market shifts, seize new opportunities, and adapt the company’s strategies to maximize competitiveness.
  • Access to Insider Information: The management team’s intimate knowledge of the company’s internal operations, strengths, and weaknesses provides them with valuable insights. This insider information can be leveraged to identify areas for improvement, optimize processes, and make informed decisions that drive the company’s growth and profitability.
  • Potential for Entrepreneurial Spirit: Management buyouts often unleash the entrepreneurial spirit within the management team. Freed from the constraints of external ownership, they can pursue innovative ideas, take calculated risks, and explore new avenues for growth, unlocking the company’s true potential.
  • Enhanced Retention and Talent Attraction: The management team’s increased ownership stake can enhance retention efforts, as they are directly invested in the company’s success. Additionally, the opportunity for management to become owners can attract top talent, as it offers a unique career advancement path and potential financial rewards tied to the company’s performance.
  • Confidentiality and Reduced External Interference: Management buyouts can be conducted confidentially, minimizing potential disruptions in the market or within the company. With reduced external interference from shareholders or board members, the management team can focus on executing their vision and strategies without undue external pressures.

It’s important to consider that the advantages listed here are general and may vary depending on the specific circumstances of the management buyout and the industry in which the company operates. Thorough analysis, professional advice, and careful planning are essential to ensure a successful management buyout.

What are the disadvantages?

  • Financial Constraints: One of the primary challenges in a management buyout is securing the necessary financing. The management team may face difficulty in obtaining sufficient funding, especially if they lack personal resources or if external investors are hesitant to provide financing without significant collateral or a proven track record.
  • Lack of Diversification: Management buyouts often require the management team to invest a significant portion of their personal wealth into the company. This concentrated investment can increase their financial risk since their wealth becomes closely tied to the success or failure of a single business. If the company encounters financial difficulties or fails, the management team may suffer substantial personal losses.
  • Conflict of Interest: In a management buyout, the management team takes on dual roles as owners and decision-makers. Balancing these roles can create conflicts of interest between personal financial gain and the best interests of the company. Decisions that prioritize short-term gains for the management team may not always align with the long-term viability and growth of the business.
  • Limited Perspective: While the management team possesses valuable industry knowledge and operational expertise, they may have limited exposure to external perspectives and new ideas. This lack of external input can hinder innovation and the adoption of best practices, potentially limiting the company’s ability to adapt to changing market conditions.
  • Potential for Strained Relationships: The negotiation and execution of a management buyout can strain relationships between the management team and other stakeholders, such as current owners, shareholders, or employees who are not part of the buyout. These strained relationships can impact collaboration, trust, and the overall dynamics within the company.

It’s important to note that the disadvantages listed here are not meant to discourage management buyouts but rather to provide a balanced perspective on potential challenges that may arise. Each situation is unique, and careful consideration should be given to both the advantages and disadvantages before proceeding with a management buyout.

What’s the difference between a leveraged buyout (LBO) and MBO?

A leveraged buyout, or LBO, is similar to an MBO in that the management team buys all or part of the business from the current owners. In contrast to an MBO, in which the purchase cash is raised from the buyout team and external investors, an LBO involves selling or pledging the company’s assets as collateral.

A lease-back financing model is similar to this one. Leasebacks involve selling hard assets, such as buildings, to raise money. As soon as the building is sold, the company will lease it back from the new owner. In this way, the company can raise funds for operations by monetising non-performing assets, while still having access to the asset for its business purposes.

The asset financing involved in LBOs is called LBO financing. Business purchases require borrowing against assets such as property, plant, and machinery. Those assets can still be used, but the new owners will have to repay the loans and pay interest until they are repaid. LBOs reduce a company’s asset value while simultaneously increasing its debt burden.

What’s the difference between MBI, MBO, and BIMBO?

In either case, a BIMBO, MBI, or MBO transaction results in a new management taking over from old management. They differ, however, in the following ways:

Management buy-in (MBI)

Third-party teams from outside the company purchase the business from its current owners to become its new managers in an MBI. The new management usually replaces the existing management in key positions. Unlike a simple trade sale, an MBI involves a buyer acquiring the business but leaving the existing management team in place. It is not uncommon for management buy-in teams to compete with other potential buyers for a business. They are often called ‘turnaround teams’. Outgoing owners may benefit from a higher sale price.

Buy-in management buyout (BIMBO)

In simple terms, a BIMBO is a hybrid purchase transaction. Essentially, it’s a combination of a merger and acquisition and a merger and acquisition. An outgoing owner sells the company to outside managers along with existing inside managers in a BIMBO. A buy-in is done by outside managers, whereas a buy-out is done by inside managers. The existing management team and the new management team enter into a purchasing partnership. When the pool of purchasers is increased, a BIMBO can reduce the amount of external borrowing required. Bringing in new talent can also enhance the business proposition for potential investors.

What are the tax implications of a management buyout?

An MBO is a complex transaction, and all too often, the buyout team is too focused on closing the deal to consider tax ramifications. Despite their mistakes, they only realise their error later, when it is time to cash out.

Entrepreneur’s Relief is one of the most important tax issues that pending new UK business owners should consider in 2021. Business Asset Disposal Relief (formerly known as ER). When selling a business, owners can use this tool to increase their financial gains. A reduced capital gains tax rate of 10% can be applied to profits made by shareholders with more than 5% of a company’s shares when they sell qualifying assets (such as their company shares). Once an individual reaches the higher tax band, their CGT rate will be halved, representing a potential savings of up to £1 million.

During the MBO, it is crucial to determine the correct ownership structure in order to capture this valuable savings. Expert tax advisors are required to assist with ER due to its strict conditions. A future budget may eliminate ER, but it currently reveals a need to avoid dividend-paying structures, such as the Company Purchase of Own Shares.

How do I finance an MBO?

Funding is the most challenging part of any MBO. When a buyout team does not have enough liquid capital to buy the business for cash there are a number of ways to finance a business acquisition. Money can be secured in the following ways:

Private loan

A combination of unsecured and secured personal loans is used by the buyout team to fund the MBO. Secured loans are secured by collateral such as homes, pension plans, and other non-cash assets. They may take the form of equity release mortgages, bank loans, or finance company loans. As with any secured lending, good credit references are usually required, and these assets are at risk if the business fails.

Business loan

Funding may be obtained by taking out a business loan from a bank or a finance company. A business purchase may qualify for unsecured lending based on its track record and type. Generally, unsecured loans are smaller than secured loans and, in many cases, the lender will take a lien on the company’s assets, including its sales ledger, in order to secure the loan. The term of a loan is usually between three and five years.

Asset finance

Asset finance allows the company’s assets, such as property, stocks, or debtors, to be leveraged against. Businesses with substantial assets may be able to take out loans or asset based lending. Leveraged buyouts refer to this type of arrangement, in which the old owner is bought out using the company’s assets. LBOs increase the balance sheet’s liabilities while reducing its assets. During the term of the loan, the business will normally have full access to the assets.

Private equity (PE)

Even at the smaller end of the market, this is a steadily increasing source of finance. In exchange for shares, board seats, dividends, fees, and varying degrees of control, venture capitalists, hedge funds, and private investors provide cash. As your company grows, you may be able to access this source of funding, but it can be harder to obtain. Investors and equity lenders often have an exit strategy that involves liquidating their position within one to three years.

A replacement funding source may be needed at that point. The lender will also be repaid based on future valuations. There is a possibility that the sum repaid will be substantially greater than the sum invested if the business has experienced growth.

Mezzanine finance

The lender has the right to convert into equity interest in the company if the company defaults, usually after venture capital companies and other senior lenders have been paid.

Seller loan

A seller loan is sometimes referred to as seller finance, vender loan or vendor finance. Some of the seller’s consideration is left in the company as loan notes to be repaid over time. Over time, their ownership decreases. Some degree of control may remain with the old owner until they are completely paid off

What are the alternatives to an MBO?

Should a management buyout is not possible, what other options is available in order to change the company ownership? This can be dependent upon a few factors such as: It depends on who you are, the owner wishing to exit, or the employees wishing to buy.

The owner wishing to exit

The company’s owner has a wide range of options to distribute their interest in the business. An MBO seems likely, but other potential candidates include:

  • Trade sale: is when a direct sale is made to a third party, these are almost competing business operating in the same sector.
  • Family transfer: is when a family member takes over the reins, family-run businesses always use this method.
  • External management introduction: is when there are issues to fix and it requires a new management team to take over the day to day running of the business. The business owner still remains in ultimate control.
  • Employee buyout: is when the shares of the business are sold to all the employees, not just the current management. this type of sale involves a  co-operative arrangement for shared ownership.
  • Stock market float: is when the shares of the business are put up for sale and offered to buyers via an IPO. The business owner will sell their shares, and the stockholders appoint new management.

The employees wishing to buy

An employee buyout is a great way to ensure that your company will continue operating in the future, especially if an MBO isn’t possible. All of those who work at this business can purchase it themselves with money or other assets and they do so by either owning outright or making payment via a deferred consideration this is done either directly or indirectly.

Indirect ownership: The employee trust is a great way for businesses and employees to share ownership. Employees can put money in the fund, which holds their shares on behalf of them- it’s like having an investor with you at every turn! The trusts dispense funds when they’re needed or pass out little bonuses from time – either way there’ll always be more where that came from thanks this awesome tool called “the Trust”.

Direct ownership: Employees can own shares in their own names. One option is for employees to acquire the businesses shares over time and this could be as bonuses, or part of what they’re paid; alternatively some people might purchase a collective trust that distributes these funds at certain intervals, though an individual will retain all rights under it – essentially having 100% ownership plus any profits made off sale(s) between now-whatever strategy you decide on. Taking the shares through an employee trust or a co-operative may be one way for employees to take control of their company. The tax benefits are significant, and raising bank finance could also become easier with this step in place.

The management team could consider starting a new business with the skills, ideas and contacts they have. This would be easier if there is no MBO option available or an employee buyout isn’t possible because it will come from their proven track record as managers that can help acquire start-up capital in forms such as investment loans & grants

How do I apply for management buyout finance?

Applying for management buyout finance has never been easier, simply complete the online enquiry and one of our team will talk you though a number of finance options that are available to you.

Read more: No money down, leveraged buy out

Lee Jones profile picture
Business Finance specialist at Invoice funding

Seasoned professional with a strong passion for the world of business finance. With over twenty years of dedicated experience in the field, my journey into the world of business finance began with a relentless curiosity for understanding the intricate workings of financial systems.

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