Management Buyout: Guide To The Management Buyout Process & Financing

management buyout
Businessmen shaking hands during a meeting.

Management buyouts (MBOs) are a common acquisition strategy that allows professional managers to become business owners. In this article, we’ll go over the management buyout process, structure, and what financing a management buyout entails.

What is a Management Buyout (MBO)?

A management buyout (MBO) is a corporate finance transaction in which the operating company’s management team acquires the business by borrowing money to buy out the current owner (s). An MBO process is a type of leveraged buyout (LBO) and is also known as a leveraged management buyout (LMBO).

The management team in an MBO process believes they can use their expertise to grow the business, improve its operations, and generate a return on their investment. The transactions typically take place when the owner-founder wishes to retire or when a majority shareholder wishes to exit.

Lenders frequently prefer to finance management buyouts because they ensure the continuity of the company’s operations and executive management team Customers and clients of the company are often pleased with the change because they can expect the same high level of service.

What is the purpose of a management buyout?

Management buyouts are chosen by huge corporations looking to sell off unimportant sections or by private-equity owners who wish to exit their enterprises.

They are undertaken by management teams in order to obtain a more explicit financial incentive for the company’s potential growth than they would otherwise be able to obtain as employees.

Management buyouts appeal to business owners because they have the assurance of the management team’s commitment and that the team will provide downside protection against negative press.

How Should a Management Buyout Process Be Approached?

If you are part of the management team that wishes to buy out the current owner(s), you must be cautious in your approach (or you may be approached by the owner).

Prepare a thoughtful proposal stating why you want to buy the business, how much you believe it is worth, and how you plan to finance the purchase.

Do your homework, which should include developing a financial model and doing thorough value research.

It is critical to understand which individuals of management will participate in the buyout and which will not. Following that, you must decide how to distribute stock in the transaction in a fair manner.

Financing a Management Buyout MBO (or LMBO)?

Management buyouts typically necessitate large capital. Financing a management buyout can be from the following sources:

#1. Debt funding

The management of a corporation may not have the resources to purchase the business itself. Borrowing from a bank is one of the most common options. Banks, on the other hand, view management buyouts as overly hazardous and may be unwilling to take the risk.

Depending on the source of finance or the bank’s assessment of the management team’s resources, management teams are typically expected to spend a large amount of capital. The bank then lends the remainder of the funds needed for the buyout.

#2. Financing provided by the seller/owner

In some situations, the seller may agree to finance the buyout with a note that is amortised over the life of the loan. The price charged at the time of sale would be nominal, with the true amount deducted from the company’s earnings in subsequent years.

#3. Financing through private equity

If a bank is unable to lend, management may resort to private equity investors to fund most buyouts. Private equity funds may lend capital in exchange for a percentage of the company’s stock, while management may also receive a loan. Private equity firms may demand managers to spend as much as they can afford in order to align the managers’ vested interests with the performance of the company.

#4. Mezzanine financing

Mezzanine finance, a hybrid of debt and equity, will boost a management team’s equity stake by combining certain loan and equity financing features without diluting ownership.

Examples of Successful Management Buyout MBO Process

To make the theory more concrete, I’ll now walk through an example of a real-life MBO and how all the puzzle pieces fit together.

Atchafalaya Measurement Company, Inc.

Atchafalaya Measurement, Inc. (AMI management )’s buyout is a fantastic example of financing a management buyout when the management group has minimal resources.

AMI is an oil and gas services firm established in Louisiana. The founders/owners were ready to retire and wanted to leave the firm in the hands of two of the company’s young, skilled managers – the founders/owners wanted to reward these managers for their hard work rather than selling the company to a competitor. The managers wanted to buy the company, but they couldn’t afford the $15 million asking price. They determined that obtaining a loan for the entire transaction value would be difficult, and they were also unwilling to personally guarantee a loan. To address this issue, the management team collaborated with a private equity firm.

The private equity company provided all of the money for the transaction and granted management a 20% equity stake with the potential to earn much more stock as the business grew. The private equity firm also assisted in the arrangement of debt financing for the transaction – having a financial sponsor partner generally gives the lender more trust in a management buyout structure. As a result, AMI’s capital structure post-closing comprised of debt and equity (the owners); the private equity firm held 80 percent of the company, and the management group controlled the remaining 20 percent.

Factors Contributing to Failed Management Buyout

An MBO can go horribly wrong. The following are some of the most prevalent MBO blunders/pitfalls:

#1. Lack of Defined Leadership

The management group (buyer) must identify an operator to lead the firm. The investment group cannot operate on a “management by committee” basis. While deciding who this CEO should be is a difficult undertaking, it is one that must be completed before the investor group purchases the asset.

#2. Different Expectations Among Partners

The management team and their partners (the other investors) do not agree on the time horizon of the investment or the business plan.

#3. Excessive Debt Financing

This is a danger in any buyout, not only management buyout funding. Debt boosts returns in a buyout, but it also reduces the margin for error.

#4. Inadequate Ownership Experience

A management buyout process is frequently the management team’s first experience owning an asset. There should be a distinction between managing an asset and owning an asset.

#5. An MBO may not be the best option for the Seller.

By nature, the sale of a company to its management team tends to have a streamlined process. As a result, it may discourage other potential buyers from viewing the asset.

How Can You Keep an MBO from Going Wrong?

Any successful MBO process should consider the following tips:

#1. Transparency

All parties should be very clear with their expectations regarding the key deal terms and the strategy for the business post-closing of the deal.

#2. Sustainability

Make sure the business that is being purchased can comfortably support the debt that is being placed on it. Run sensitivity analyses. Think of a bad operating scenario and see if the business can still service its debt in that scenario. Make sure the advisor has an experience in financing modeling; that way, they can work with management to construct financial scenarios and perform the necessary analyses based on these scenarios.

#3. Skills blend

Be sure the management group that is purchasing the company has the right combination of skills. You don’t want four CFOs running the Company. This issue will be addressed in the advisor’s initial meeting with the team and will be a constant discussion throughout the process.

#4. Share the wealth

The management group should consider sharing equity with employees at the company. This could be done through the outright issuance of shares or a combination of performance-based and time-based vesting options. A shared incentive structure will be a powerful driver of successful outcomes for the business.

#5. Keep it low-key

The management group shouldn’t tell everyone what they are up to, they don’t want to let word get out. This could distract the company’s key stakeholders and/or trigger an auction process that could cause the management team to lose the asset. Advisors should be able to work in discrete situations.

Management Buyout FAQ’s

Is LBO same as MBO?

While LBO stands for a leveraged buyout, MBO stands for a management buyout. While many people believe that MBO is fundamentally different from LBO, experts explain that MBO is a subset of LBO in which internal management takes over effective control of the company rather than an outsider.

What is buyout process?

A buyout is a process of acquiring a controlling interest in another company, either through outright purchase or through the acquisition of a controlling stock position.

How is an MBO funded?

Financing an MBO often entails bringing together funds from a variety of sources, both personal and external, and frequently a combination of debt (loans) and equity.

  1. Leveraged Buyout Model: Definition, Types & Examples
  2. EQUITY FINANCING: Types, Sources, Advantages & Disadvantages
  3. Invoice Financing: Definition, Types, Pros & Cons
  4. CONSUMER FINANCING: Best Financing Companies & Programs
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