Introduction to Management Buyouts

Introduction to Management Buyouts

A management buyout is a transaction where the existing management team of a company acquires the business from its current owners. There will be a number of key players, including investors, lenders, and legal advisors, but most important is having an experienced and highly motivated management team who are willing and able to take the business forward.

A management buyout (MBO) can be beneficial to all parties. Not only does it provide the current owners with the comfort of knowing that the business is in safe hands after they've left, but the process can also be simpler than one involving a sale to a third party, because the management team will already know the business inside out. For the management team, it often allows flexibility in terms of payment of the purchase price in circumstances where finance can be expensive or unavailable, as well as motivation to ensure that the business continues to succeed.

Overall, it is a highly flexible exit approach which can provide the current owners with a rewarding handover, whilst also being seen as a reward to the management team for their previous hard work.

Structuring a Management Buyout

Whether a management buyout transaction is instigated by the current owners or the existing management team, it is critical to identify and involve those individuals who will comprise the purchasing management team as early as possible in order to establish if they have the appetite to take the business on. Structuring the actual management buyout deal will then involve putting in place a good team of professional advisors for both the current owners (as sellers) and the management team (as buyers) at an early stage in order to help build the best possible structure for the transaction.

Valuation of the business is critical to any management buyout. It may be possible for the parties to agree a valuation for the business between them, but if not, instructing an accountant to assist with the valuation should result in an objective figure to both satisfy the management team that they are not paying over the odds for the business, as well as ensuring that the expectations of the current owners are realistic. If the current owners have unrealistic expectations as to value, then this will serve not only to lessen the management's interest in the deal, but also to limit their ability to obtain finance. If the management team needs to obtain finance to complete the management buyout, then obtaining a valuation may be particularly important to ensure that the management team can present this valuation as part of their funding application.

Securing the necessary funds is a significant challenge in management buyouts. Management buyouts will usually be financed by a combination of the release of free cash, debt and seller financing. Seller financing is where the current owners agree the consideration to be paid over a period following completion rather than at completion. It is important for all parties to work with their professional advisors to structure the consideration in a way that limits the risks for the current owners but also ensures that the management team can realistically service any payment obligations. Often agreeing the form of consideration payable to the exiting sellers will be dependent on the finance available to the management team, and it can take compromise on both sides.

Once a management buyout structure, valuation, and finance arrangements have been established, it'll be time to document the transaction. The legal advisors should work closely with the parties to draft the documentation in a sufficiently comprehensive manner to ensure that all of the parties’ understanding of the transaction is correctly recorded. Issues can unfortunately occur after completion of a management buyout where the parties have been overly relaxed in the documentation, and this can lead to disputes and ultimately disappointment.

Navigating Legalities in a Management Buyout

Completion of the management buyout broadly involves the same process as a sale to a third party purchaser, but because the existing management team already knows the business, and will likely require less due diligence on the target business, it can often be a quicker process. However, the current owners should still expect to be required to agree and execute key documents, such as a sale agreement and disclosure letter, as well as other ancillary documentation such as settlement agreements and director's resignation letters.

Some common challenges will often rise around how the consideration is paid, especially if it is not all paid at completion. If the consideration is deferred and to be paid later, the current owners may quite reasonably require the company and the management team to provide them with some security, in the form of a debenture or (if the management team are using an SPV for the purchase) personal guarantees, to protect them against the payment commitments not being honoured.

Whilst it would be usual for the existing sellers to give less protection to the management team than to a third party purchaser in the form of warranties (bearing in mind the management team’s existing knowledge of the business), there may still be areas where information has been historically kept from them by the current owners and in respect of which, the management team may need additional protection in terms of warranties and/ or indemnities. If the management team purchaser is required to obtain finance to complete the purchase, the finance provider may require them to have documentation which is more comprehensive than was anticipated. The parties need to try and find a flexible middle ground which is acceptable to all.

Advisors play a crucial role in steering the management buyout through complexities and areas of disagreement because usually they will have seen the same points arise time and time again. A good advisor can make suggestions that they've seen work in the past, and this can ease tensions between the parties, which could otherwise lead to the deal stalling or collapsing altogether.

Managing Team Dynamics in Management Buyouts

From concerns about job security to changes in leadership, it is clear that some aspects of management buyouts need to be dealt with carefully to ensure that there is a successful and profitable transition to the management team purchasers. Communication is key during times of transition, and it is especially important to ensure that the plans for the business are clearly communicated where a management buyout is proposed. Clear communication will ensure that employees retain their sense of job security and motivation in the transition period. This gives the business the opportunity to retain the best staff for the future and to ensure that high motivation and morale are retained. Of course, there will be employees who are not part of the purchasing management team, and it is important to remember that they need to be motivated as well. It may be necessary to consider specific alternative incentives for those key members of staff to ensure that they stay in the business after completion of the management buyout.

Post Management Buyout Strategies for Long Term Success

Once a transaction is complete for the management team, the real work is just beginning. While it is exciting to know that they own the business, it can be a high-pressure time, especially given the financial obligations agreed as part of the management buyout. At this important time, it is in both the exiting owners’ and the management team purchasers’ interests to seamlessly integrate their operations, people, and culture for maximum synergy.

As part of a management buyout, it will be important to have a well-structured business plan to implement following completion. This will embrace the enthusiasm and energy of the management team purchasers and maximise the possibility for success. Often new business owners will look to implement fresh ideas and to make synergies which can lead to higher profits, but it is important to plan and implement these ideas in a measured way. A good business plan will help with this. Business plans for management buyouts will need to foster a culture of continuous improvement and innovation, ensuring that the acquired business remains competitive in an ever-involving market.

Continuous communication will be a key to this success because this will ensure that the entire employee pool is on the same track and that they fully understand what the business is trying to achieve. The management team purchasers should use clear communication with the employees to ensure that no one is left excluded or unmotivated. It may be that the employee incentives need to be reviewed to ensure that there is an inclusive culture that can be continued.

If the management buyout is successful, as everyone hopes, then it may be possible to repay finance users as part of the deal earlier than expected, and this will enhance the profit then available to the management team. However, the focus should be on steady repayment of funds, ensuring that the business does not take unnecessary risks.