Business owners: is a management buyout the most convenient exit?

Selling a business is often a once-in-a-lifetime event and can be stressful for owners, particularly if building that business has been a life’s work – and can impact on loyal customers and a committed workforce.

Whilst a trade sale might seem the most obvious route to exit, a management buyout (MBO) can often be a better solution.

Overview

Since the 1990s, MBOs have been a very popular way for company owners to dispose of their shareholdings on retirement or earlier exit. From the perspective of managers, an MBO is seen as attractive as it offers the opportunity for them to satisfy their entrepreneurial spirit, by acquiring a significant equity stake in the business that they work in and understand.

An MBO avoids the need for the shareholders to go to the market to locate a buyer and, accordingly the sale can be completed without the competition and market in general becoming aware of the shareholders’ intentions. It also often appeals to the owners to know that the company will largely continue in its present form.

Funding an MBO

Most management teams think that an MBO is out of the question because they do not have access to the full funding required to buy the company in which they work. The reality is that most of the money is raised from institutional investors / lenders, each of the team members only typically being required to invest a sum that shows commitment to the MBO, but is within their reach.

The principal sources of funding for a buy-out are:

1. Management team: Personal investment by each member of the MBO team
2. Debt from a bank or asset-based lender: Primarily funds lent against the assets of the business, e.g. plant & machinery, stock, property, trade debtors, but often also as a term loan based on the proven earnings of the business
3. Private equity investor: Funding in exchange for an equity stake in the business. The level of equity required is dependent upon many factors, however many PE investors funding MBOs are looking at a typical stake of 25 percent to 49 percent
4. Deferral of part/all of the consideration: To reduce the funding requirement at completion of the MBO, the owners are often prepared to defer payment of part of the sale consideration. Such a deferral will often negate the need for an equity investor, the existing owners effectively becoming the equity backer, and being repaid out of cash generated from future profits. The existing owners may also look to retain an equity stake going forward.

Process

Specialist advisers should be brought in on all but the simplest of MBOs. The advisers will effectively ‘project manage’ the process from start to finish. A typical MBO runs to many parts, including:

1. Agreeing a deal between current shareholders and MBO team
2. Negotiation and preparation of Heads of Agreement
3. Preparation of a business plan, setting out the company’s current position, where the Team intends to take the business over the next 3-5 years and the strategy for doing this
4. Presentation of the business plan to potential funders
5. Negotiation with funders, through to acceptance of a funding offer
6. Funder due diligence, i.e. financial, commercial, legal and sometimes profiling the team members
7. When it is apparent that due diligence has not raised any major issues, then lawyers acting for the management team and existing owners will start work on the sale and purchase agreement, i.e. the contract setting out all terms of the transaction. By this stage the MBO team’s lawyers will have formed a new company to be the vehicle for buying the company
8. Lawyers for the funder(s) will agree with the MBO team’s lawyers the documentation that reflects the terms on which the funding is being made available to complete the transaction
9. The transaction will be legally completed when all documentation is agreed and signed by the parties and the agreed completion consideration has been paid.

In conclusion

The high number of such transactions completed over the last twenty plus years is clear evidence that MBOs are an excellent way for businesses to move from one generation of ownership to the next. We have many years’ experience advising on such transactions, and would be delighted to speak with managers and business owners interested in exploring such an opportunity.

Please email the author, Darren Hurdle, or member of our corporate finance team through our contact form for assistance on any of the above issues.

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