When planning an exit strategy, one of the first areas to review is the strength of the management team. Not only is this one of the pivotal areas in determining value when presenting the business for sale to third parties, but it will also allow exiting shareholders to evaluate whether a management buy-out (MBO) could well be a viable option.
MBOs are not for every business—in order for them to be an option the remaining management team require both the skill set and experience to be able to step up and before the duties of the exiting shareholders, as well as importantly the desire. Some employees are happy just being employees—the added stresses and strains of taking the leap to becoming a business owner is not for everyone. However, if you do have an ambitious management team in place who are hungry to take the business forward under their ownership, then this presents a serious option for consideration when planning your exit.
Advantages of an MBO
One of the main concerns of running a mandated sales process is the risk of a confidentiality breach. While non-disclosure agreements and confidentiality undertakings will be secured by competent advisors prior to engaging with third parties, the risk remains that word of a sale could get around to staff, suppliers or customers, unsettling the business and potentially affecting future profits and value if a sale is unsuccessful. Going through an MBO process ensures that all communication is kept in house, limiting the risk of third parties becoming aware and of confidentiality breaches occurring.
Another advantage is that the departing owners know the business is being kept in safe hands. Typically management teams will understand and share the ethics and ethos which has helped make the business a success, ensuring that staff, customers and suppliers receive this continuity of service long after the original shareholders have exited. When selling to a trade party, however, there is significantly higher potential that in the short- to medium-term changes will be made to unlock synergy savings, which could involve numerous changes including the name of the business or even redundancies.
Disadvantages of an MBO
Typically the value received from an MBO will be less than could be achieved from a sale to a strategic buyer, and the shareholders will need to be comfortable that an MBO will likely not result in them maximizing full value. This is typically due to the fact that MBOs are either debt (being lending against assets with term loan from a bank or funder) or equity funded. For most companies, the amount of debt that they can leverage against their assets (and still be able to comfortably pay off going forward) in the current market is significantly below a profits/free cash flow multiple that a strategic buyer could be willing pay.
Private equity-backed MBOs can deliver higher values than purely debt funded calculations, however in order for private equity to consider an MBO, then growth becomes an important criteria alongside the abilities of the remaining management team. Private equity investors will freely admit that they back management teams, not companies, and this means the team itself needs to all be in place, or have identified in advance gaps which a new investor might help fill, pre-completion.
The MBO team will need to have a clear plan for significant growth, and the skills and experience to execute it, as the private equity investors will be looking to achieve this growth before then seeking to exit themselves and deliver a return to their investors. This can be attractive to the management team, as if they obtain ‘sweet equity’ (being the ownership stake acquired at nominal cost) then this can create a massive upside for them should they deliver on their plan. However if the company cannot demonstrate a compelling growth story, then the private equity funded option will not be on the table.
Early on in discussions relating to an exit strategy, a good corporate finance advisor or investment banker will explore the options of an MBO with the shareholders, ascertaining whether this could be an option in the short to medium term with the current team or through the addition of one or two new senior personnel. Should this be the preferred route, then building a compelling and credible business plan is necessary, underpinned by a detailed financial model which can stand up to third party analysis and scrutiny.
In summary an MBO is a delicate balancing act between a number of parties, some of whom will have conflicting interests at certain points. However if these can be overcome, then it can be the perfect resolution for the shareholders and the continuing management team.