How to Make a Successful Management Buyout (MBO) and What are its Advantages and Disadvantages?
Management buyout or MBO happens when a company’s management team aims to take control of a business and chooses to buyout and own the shares of all or part of the business. This type of buyout helps them to garner potential rewards from the business.
However, there are several important things to consider before executing an MBO. This blog dissects the concept of a management buyout and its nitty-gritties.
What is a Management Buyout (MBO)?
A management buyout is 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.
A management buyout is a popular mechanism to grow small businesses. Large public sectors also use MBO to transition into private firms. This helps them to streamline their operation and increase profitability.
A company can opt for a management buyout for the following reasons.
- A management team has a better vision to extend the business as new owners.
- The old owner wishes to resign from their role.
- Despite having a potential to soar high, this company is in distress.
- When a parent company wishes to divest its powers from one of its subsidiaries, it can allow an MBO.
Ranbaxy Fine Chemicals, Tebma Shipyard and Ace Refractories are examples of management buyouts by ICICI Ventures.
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.
A management buyout ensures that the company is in the safe hands of its employees. They do not need to worry about finding suitable new owners as their managers know the company quite well.
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.
What is the Process of a Management Buyout?
A management buyout is a process under which a company’s management team strives to acquire a company or companies they manage. The acquisition procedure tends to follow the steps mentioned 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
This 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.
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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:
- Senior Debt Lenders: They are direct lenders, institutional investors and traditional banks.
- Equity Contributors: This includes rollover equity and financial sponsor contributors.
- 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.
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.
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
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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.
FAQs
Ans. Like a management buyout, management buy-in (MBI) occurs when external management acquires a company’s ownership rights.
Ans. You can opt for credit options such as asset financing, debt financing, vendor loan notes and private equity for MBO transactions.
Ans. Shareholders’ agreements, tax deeds, bank finance documents, and employment contracts.
Ans: Stock and asset purchases are two very common modes of management buyouts today.
Ans. 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.
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