What is Management Buyout (MBO) – Process and Example
A management buyout means a type of business acquisition where a business is acquired from its existing owners by its management team. When there is a management buyout, the management team takes full control of its business from its previous owner.
An MBO transaction tends to happen when the firm’s previous owner chooses to retire or opt for new ventures. Its management team, who is well aware of the company, steps up as new owners to grow it. When an MBO purchase happens, the management team purchases everything related to business from the owner.
How Does a Management Buyout Work?
Like every other corporate transaction, management buyouts must follow the country’s legal and financial procedures. Management buyout occurs when one of these two scenarios takes place. One of them involves an exit strategy. Here, a large firm decides to sell a business that is no more part of its core business.
The second scenario is when the owner decides to retire from his position. In such an instance, an owner can choose to sell the company’s acquisition to their management team. If the management team feels they have the expertise and resources to take over, they will opt for a buyout.
The management buyout process may take six months or more to complete. However, it can take longer time in the case of large firms. This is because the management and operation team continues with their normal business roles as the power transfer occurs.
Lenders also prefer financing management buyouts as the business continues operating for longer. This ensures fewer risks of defaulting to lenders. In addition, as the company managers take over, clients and customers do not lose their trust in the business.
Reasons for Management Buyout
- Members of management may disagree with the company’s direction. They may feel more in control of the business, its success, and its future if they carry out an MBO.
- Members of the management team may feel as if they aren’t reaping the full financial benefits of running the business. They can reap the benefits by acquiring the company.
- Management may believe that the owner(s) lacks the knowledge and ability to lead the company. Corporate management may have the educational or work experience to help them guide the company to new heights, and they may believe that an MBO is the only way to do so.
What is the Process of a Management Buyout?
A management buyout is a situation under which a company’s management team strives to acquire a company or companies they manage. The Managment Buyout procedure are mention below
Step 1: Analysis
This initial step includes market analysis, SWOT analysis, products and competitors of the business. This usually does not take much time for management buyouts, as managers know the company’s standings.
Step 2: Negotiation Procedure
This is a critical process as the buyers and sellers negotiate and settle on common ground regarding the company’s price. Mutual negotiations occur after sellers and buyers settle on a price based on their independent valuations.
Step 3: Financial Analysis
The third step helps the buyout team prepare for the next step, which is the acquisition of financials. With financial analysis, managers can present charts about their company’s upcoming models and finances to their shareholders and investors. This is vital for any company to publish such data to hold onto its investors’ trust.
Step 4: Acquirement of MBO Funding by Buyers
The management team sets forth to gather the necessary funds they agreed upon to purchase the company from sellers. The management team can opt for personal or financial funding.
Step 5: Planning for Transition
The transition process begins as all teams coordinate to execute their transfer plan. Then, they make the necessary changes in communication, tax, organisational management and succession.
Step 6: Transaction Purchase
The management buyout process at this stage has to ensure legal compliance as per State and National rules to complete the transaction process.
Step 7: Ownership Transfer
This step overlooks the transfer of powers at a company’s top-tier level. All ownership and decision-making roles transfer to the new owners from the old ones. This transfer of powers can take a few months to years, depending on the firm.
Step 8: Funding Paybacks
This is the last step of setting up a management buyout. Here, the management buyout team repays financial institutions and equity firms with MBO funds which they gain from increments.
Structure of a Management Buyout Transaction
The structure of management buyout transactions combines both debt and equity financial institutions.
Following are some of the sources of funding for management buyout:
1. Senior Debt Lenders
They are direct lenders, institutional investors and traditional banks.
2. Equity Contributors
This includes rollover equity and financial sponsor contributors.
3. Subordinate Debt Lenders
These are hybrid financial instruments.
The rollover equity helps reduce the following:
- Equity Contributions: the equity funding by any private equity firm
- Debt Financing: this is the total amount of debt funding a company needs to raise for MBO
How to Approach a Management Buyout?
Before planning a company’s transaction process, buyers must conduct thorough research. They must incorporate the following points while designing their proposal for a management buyout:
- Reason for buyout
- Terms of the deal should also include purchase price
- Mode to finance the MBO
- Managers who are part of a management buyout
- Their plans and intentions for the company after a successful management buyout
Adding these points to the proposal reflects that the management team are well aware of the company’s potential. It also highlights that they have done their homework and are reliable internal members whose hands the business’s future can rest.
The management team must also go for the right financial sources to acquire money to go ahead with the MBO. Below are a few capital sources that can provide the MBO team with the required finances.
1. Private Equity Firms
These firms provide finances to the MBO team if banks reject their offers. However, these firms tend to own a part of the company’s shares if they grant a loan to the management team.
2. Debt
Banks are usually the first doors the management knocks on for MBO funds. However, banks consider MBO as a risky undertaking to lend money. This leaves the MBO team to look for primary funding before venturing to other lenders.
3. Other Forms of Financing
The management team may also opt for owner financing, where buyers must repay the seller with borrowed funds. They can also choose mezzanine financing, a mixture of debts and equity.
Also Read
How to Finance an MBO (or LMBO)?
A Management Buyout (MBO) is a transaction where the management team of a company purchases the business from its current owners. Here are some common ways to finance an MBO:
1. Debt Financing
This entails borrowing funds from lenders such as banks or private equity firms to fund the purchase. The debt can take the form of senior debt, mezzanine debt, or subordinated debt, depending on the lender’s risk appetite and the company’s creditworthiness.
2. Equity Financing
To finance the purchase, capital is raised from investors such as venture capitalists or private equity firms. Depending on the investor’s preferences, the equity can take the form of common stock, preferred stock, or convertible securities.
3. Seller Financing
Negotiating with the current owners to provide financing for the purchase is required. To finance the transaction, the seller may be willing to accept a note or make a loan to the management team.
4. Earn-out Financing
This entails structuring the purchase price so that a portion of it is paid out based on the business’s performance following the MBO. This can help to align the interests of the management team and the current owners while also lowering the amount of money needed up front for the transaction.
5. Mezzanine Financing
This entails raising capital from investors willing to take on more risk in exchange for higher returns. Mezzanine financing typically has a higher interest rate than senior debt and may include some equity. It is frequently used to fill the void between senior debt and equity financing.
Example of an MBO
An example of a successful Management Buyout (MBO) is the acquisition of the UK-based travel company, Thomas Cook, in 2013. Thomas Cook was a publicly traded company that had been struggling financially, and its management team saw an opportunity to turn the business around through an MBO.
The management team, led by CEO Harriet Green, negotiated a deal with the board of directors to purchase the company for £1 ($1.40) and assume its debt. The MBO was financed through a combination of debt and equity, with private equity firms, such as West Face Capital and Standard Life Investments, providing the necessary funding.
Following the acquisition, the management team implemented a turnaround plan that involved restructuring the business, divesting non-core assets, and focusing on the core travel business. The company also invested in new technology and digital platforms to improve its customer experience and expand its reach.
The MBO proved to be a success, as Thomas Cook returned to profitability and its share price increased significantly. The company was able to pay off its debt and went public again in 2018.
Advantages of Management Buyout
The advantages of management buyouts are given below.
- The management team gathers resources and does not let the company terminate its employees. This helps the firm maintain and improve its brand value.
- It is a good investment opportunity for private equity and hedge funds.
- MBO system is simple and easy to understand for people of every intellectual level.
- They maintain the company’s structure and therefore have high chances of success and well-execution.
- Negotiations for management buyouts are usually not complex but straightforward.
- It is an adequate system for small businesses and start-ups.
- As the firm’s employees become its new owners after this acquisition, MBO helps maintain a high degree of confidentiality. The secret recipe for their success remains hidden from the outside world.
Disadvantages of Management Buyout
There are certain disadvantages to management buyouts as well. Following are a few disadvantages of management buyouts:
- It can result in a conflict of interest between two parties.
- Management buyout team might face a challenge in raising funds for MBO.
- There are high risks of insider trading by any management executives.
- As the existing management takes over its business, the firm will continue to run on same orthodox plans. This may close doors for new ideas and entrepreneurs to set in the firm.
- Transition can be tough for owners and employees.
Management Buyout (MBO) vs. Management Buy-in (MBI)
| Management Buyout | Management Buy-in |
| MBO occurs when the current management team of the company purchases the business from the existing owners. | MBI occurs when an outside management team buys a company and replaces the existing management team. |
| The management team is already familiar with the business and has a track record of running it. Therefore, there is typically less risk and potentially more reward for the management team | The management team is taking on a new business and may face a steeper learning curve and higher risk. |
| The existing management team may retain ownership of the company or a significant stake in it. | The external management team typically takes full ownership of the business. |
Difference between Leveraged Buyouts and Management Buyouts
Unlike management buyouts, leveraged buyouts take place when an outsider arranges money to buy out sufficient stocks to control the company’s equity. Banks tend to prefer a leveraged buyout more than an MBO. Consequently, banks and debt capitals offer funds to them. Let us see how LBO differs from MBO, as the points below explain.
- The management team internally funds MBO financing. In contrast, interested buyers opt for external financing for LBO.
- When an MBO purchase happens, its management team remains the same. However, if a firm welcomes new owners, its management is likely to change in LBO.
- MBO happens when a company’s manager acquires the company’s ownership.
- Leveraged Management buyout comes with a lot of debts, unlike management buyouts.
Tax Implications of a Management Buyout
The tax implication of a management buyout varies based on the circumstances and details of the transaction. It will also depend on the taxation rules for the country where an MBO takes place.
Given below are a few potential taxes that might apply to management buyouts:
- Stamp duty on any contract or agreement related to a transaction
- Capital gains tax based on the sales price and purchase price of the firm
- Corporation taxes
Top 10 Things to Consider When Planning a Management Buyout
- Investigate the transaction’s viability.
- Communicate openly and transparently with executives and shareholders.
- Key employees were cut out of the deal (share the equity)
- Create a solid employee and customer retention strategy.
- Develop a thorough understanding of the company’s worth (financial modelling and valuation)
- Get your financing in order.
- Maintain a friendly demeanour.
- Create a thorough shareholders’ agreement.
- Don’t neglect the business’s operations while working on the deal.
- Determine the appropriate legal structure for the transaction, such as a stock purchase or asset purchase, and engage legal counsel to draft and negotiate the necessary legal documents.
Final Word
Management buyout happens when managers or the management team purchases a firm’s acquisition rights from its original owner. An MBO process helps ensure that a company does not cease to function and grow after its owner retires or resigns. Such buyouts can happen for small and large firms and are equally important for both.
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FAQs
Like a management buyout, management buy-in (MBI) occurs when external management acquires a company’s ownership rights.
You can opt for credit options such as asset financing, debt financing, vendor loan notes and private equity for MBO transactions.
Shareholders’ agreements, tax deeds, bank finance documents, and employment contracts.
Stock and asset purchases are two very common modes of management buyouts today.
When an outsider purchases another company with the help of borrowed money like loans and bonds, it is called a leveraged buyout. The company’s assets work as leverage against loans that financial institutions grant to buyers.
Hedge funds and major financiers view management buyouts as good investments and typically advocate for privatization to enhance efficiency and profitability through focused operations outside the public scrutiny.
In an MBO, the company’s current management team buys the business from the existing owners. In an MBI, an external management team buys the company and replaces the existing management team.
The three types of MBO objectives are as follows :
1. Strategic: These are the broad, overarching goals established by company management in step one. These should always be established first and then used to determine subsequent goals.
2. Tactical or Team: Teams or departments are given more specific goals. This type of goal may necessitate the collaboration of other teams or groups in order to achieve a common goal.
3. Individual or operational objectives: Individual objectives. These can vary greatly from employee to employee.
Disclaimer
This article is solely for educational purposes. Navi doesn't take any responsibility for the information or claims made in the blog.
