Management Buyout (MBO)

 The management team of a corporation buys the assets and operations of the company they run in a deal 

The management team of a corporation buys the assets and operations of the company they run in a deal known as a management buyout (MBO).  

Management Buyout

Professional managers are drawn to management buyouts due to the increased potential benefits and power that come with being owners rather than company employees.

A management buyout (MBO), in its most basic definition, is a corporate acquisition in which the management team pools resources to buy all or a portion of the company they run. Any sector and any size of organization can experience MBOs. 

They can be used to separate a specific department from the central business or to monetize an owner's interest in the company. An MBO can sometimes convert a publicly listed firm to a private one.

A leveraged buyout (LBO) is a transaction in which a business is bought using a combination of stock and debt so that the firm's cash flow is the collateral used to secure and return the borrowed money. An MBO is often a more precise variation of an LBO. 

Management teams typically need to obtain debt to finance the acquisition because they are rarely financially able to purchase the target firm altogether.

The leveraged buyout has roots that date back to the 1960s. One of the earliest notable leveraged buyout operations was the acquisition of Orkin Exterminating Company in 1964. With the advent of high-yield financing, or "junk bonds," the 1980s saw a surge in buyouts. 

It is estimated that over 2,000 leveraged buyout deals, with a combined value of more than $250 billion, took place between 1979 and 1989. (Journal of Finance).

Incentives to do an MBO

Incentives

The seller and the buyer have solid motives for carrying out an MBO. An MBO provides an owner piece of mind that they are transferring the firm to a group they know and trust when they are ready to retire and cash out. 

A company's heritage counts a lot in these instances, especially if the business is family-owned or employs a sizable workforce in a small community.

The management buyout procedure offers the seller tactical benefits as well. Dealing with the company's management lowers the owner's risk of revealing sensitive information during the sale process. 

Additionally, since the buyer has been running the business, the closing procedure can go faster.

A firm may find MBOs attractive because they may use them to "go private" and carry out a long-term turnaround out of the public spotlight, as Dell did, or sell or divest a segment that is no longer essential to their operations or of interest to their shareholders.

An MBO is also appealing to the management team that will be the buyer. The management wants to receive more immediate monetary compensation for the effort they are making to increase the company's worth. 

Business Analysis

A management group that seeks an MBO is certain that they can utilize their knowledge and skills to expand the company and enhance operations. As a result, people want to invest in their businesses to invest in themselves.

An MBO is frequently the most straightforward, fastest, and least dangerous option for specific management teams to acquire a significant ownership position in a company. Because the purchasers in an MBO have seen the asset firsthand, the investment's risk should be lower.

The benefits of an MBO extend beyond the buyer and seller. Customers, suppliers, workers, and lenders frequently assist in financing these deals and are all supporters of MBOs. 

These diverse constituencies feel more secure knowing that business operations and customer service will continue since the current management team will remain in place.

Steps in an Management Buyout

Steps

An MBO must be implemented in stages. The management team must first establish experience and credibility with the present owner or owners of the business (hence, "owners"). This is a long-term strategy. Over time, the management group will do this by:

  1. Performing well as a business manager, and 

  2. Maintaining regular, open communication with the company's owners.

This firm is perhaps the owners' most prized possession after their families. Thus, they will only entrust its administration to a group they believe to be reliable and capable.

The management team will then locate a chance to buy the business they are currently working for and develop a strategy. Several things can "catalyze" the opportunity's "identification":

  • The company's present proprietors may retire and have no one to transfer the company to.

  • The management team may decide that they want to be business owners and that if they can't own the company they are managing, they will hunt for another chance.

  • The company can be struggling, and the management team-or even the previous management team-might have a different plan than the ones the present owners are using.

Pre-offer

Whatever the reason for the opportunity or the desire to acquire the company, the management team must begin making plans. How will they finance the asset and operate it after the purchase? 

Building a financial model, determining valuation terms, outlining their company strategy, and determining each team member's specific roles within that strategy are just a few of the activities involved in this planning stage. 

Pre-offer

Management can do all the textbook corporate finance analysis it wants regarding valuation. Still, it must be ready for the owners' ambitious perspective of the company's worth, as they usually do.

The management team should use its knowledge of the firm during this planning phase to document the principal risks and concerns about their investment in buying the company.

The management team approaches the owners with an offer to buy the business after finishing their initial task. Depending on the dynamic between the management group and the owners, this stage can be carried out in various ways and is more an art than a science. 

The owners may occasionally engage in a casual discussion with the management team, during which they show their interest and offer high-level insights on their valuation parameters. 

Planning

In other situations, the management group could write the owners a formal letter outlining the details of the transaction.

Regardless of the technique used, the management team's (prospective buyers) objectives at this point are to clearly express their interest in a deal, learn more about the owners (prospective sellers), and persuade the owners that the management team is the best buyer.

This process can occasionally be reversed. The owners will discuss purchasing the business with the management group. The owners will consider the worth of the company. The management team must determine if this is a price they can live with. 

Can they spend this much money to buy the business and yet get a respectable return on their investment?

Post-offer

Post-offer

The management group's next task is to raise the capital needed to buy the company. Usually, the management group lacks sufficient funds to cover the entire acquisition cost. 

The management team will thus look for financial partners, including banks, mezzanine lenders, financial sponsors, or private equity companies.

During investor/lender presentations and one-on-one meetings, the management team will be required to pitch the asset and themselves to possible funding partners.

Due diligence is the last stage before the deal is closed. The management team and its financial partners "kick the tires" and make every effort to gain as much knowledge about the company as they can. 

During this stage, management should be guided by the list of important questions and risks created during the planning phase. Management should endeavor to address and reduce each issue and risk. 

Arrow

Management and its partners should also make sure there are no newly discovered hazards or liabilities that increase the risk of the transaction (potential loss of a significant customer, outstanding litigation, liens on assets, etc.)

Buyers frequently contract with several specialists to do their due diligence. A market size study, a review of legal and regulatory duties, and an appraisal of the quality of earnings are just a few of the steps that may be conducted at this point. 

The purchasers and their legal team will simultaneously negotiate the purchase agreement and other legal papers required to finalize the deal during this phase.

Given the buyer's familiarity with the business, the diligence process in an MBO should be shortened (compared to a deal in which the asset is being acquired by an outside party). However, the management group and its partners must use the usual caution.

How to finance an MBO

Laptop

Management buyouts typically demand significant capital. The following sources of funding are available for management buyouts:

  • Debt financing

The management of a corporation may not always have the funds available to purchase the company outright. Borrowing money from a bank is one of the most popular choices. 

Banks, however, might not be prepared to bear the risk as they view management buyouts as being too hazardous.

Depending on the financing source or the bank's assessment of the management team's resources, management teams are typically required to spend a considerable amount of cash. The bank then extends a loan for the balance needed for the buyout.

In some circumstances, the seller could consent to fund the buyout with an amortizing note. The true price would be charged out of the company's earnings over the next few years, with just a nominal price being charged at the moment of sale.

Key

The management will often turn to private equity groups to finance the majority of buyouts if a bank is hesitant to lend. The management will also get a loan, although private equity groups may offer to finance a percentage of the company's shares. 

To bind the managers' vested interest in the company's performance, the private equity firms could demand that they invest as much as they can.

Mezzanine finance, which combines debt and equity, will strengthen the management team's equity involvement by combining specific loan financing and equity financing characteristics without diluting ownership.

Factors that lead to the failure of MBOs

Factors

An MBO seems like a really good arrangement thus far. A group of managers that appear competent purchase a company they are familiar with. The management team implements its carefully thought-out plan, ultimately boosting the company's earnings potential and value. 

The management team and its financial partners profit from owning this more valuable asset. Other stakeholders in the company, such as employees and suppliers, can participate in a steady-going concern at the same time. 

But don't be deceived. An MBO may not work out. The typical errors or problems when using an MBO include:

  • Lack of clearly defined leadership

The management team (buyer) must name an operator to lead the company. There can be no "management by committee" in the investment group. Before the investment group buys the asset, it is necessary to reach a consensus on the CEO. This is not a simple operation.

  • Different expectations among partners

The management team's partners (the other investors) do not have exact expectations for the investment's time horizon or business plan

When a management team joins a private equity firm, duration mismatch is a frequent problem. For example, the management team may choose a 20-year hold time, while the private equity group has a five-year hold period.

Debt

  •  Over-debt financing of the transaction 

This is a concern in every buyout, not only with funding for management buyouts. Debt increases profits in buyouts, but it also narrows the error window. A good example is the most recent bankruptcy of Toys "R" US.

  • Lack of ownership experience 

For the management team, a management buyout agreement is frequently their first exposure to asset ownership. The two concepts of asset ownership and asset management are distinct.

  • The greatest bargain for the seller may not be an MBO. 

The process of selling a firm to its management team is usually straightforward. As a result, this procedure can prevent other prospective purchasers from viewing the asset. 

Additionally, the management team interested in buying the business can be motivated to harm its short-term performance (before finalizing its sale) to reduce the acquisition price (sounds vicious, but it happens).

How Can an MBO Be Prevented from Going Bad?

Strategy

The good news is that a well-thought-out management buyout process makes it possible to avoid many of these hazards. 

It is absurd to expect the management team, who are still responsible for operating the business, for completing a sale without assistance. 

A skilled adviser will explain to the management what to anticipate at each step, do valuation research, oversee the due diligence procedures, and encourage discussions among the management team members and between the management team, seller, and finance partners.

No two deals are the same, but an independent adviser may use their knowledge from past sales to assist resolve any problems or barriers that arise. Deals have one thing in common: issues usually occur!

Any effective MBO procedure should take into account the following advice:

Integrity

  • Transparency

Each party should be extremely clear about what they expect from the significant agreement parameters and the plan for the company once the deal closes. 

Meeting with the whole buyer/management team to go through the procedure and the plan for purchasing the firm and after the purchase is one of the first things an adviser will do.

  • Sustainability

Verify that the company being bought can sustain the debt imposed on it. Performing sensitivity analyses Consider a problematic operational situation and determine if the company could still pay its debt in that circumstance. 

Verify the advisor's finance modeling expertise so they can collaborate with management to create financial scenarios and do the essential analysis.

  • Blend of capabilities

Check whether the management team buying the business has the proper mix of abilities. Four CFOs overseeing the company is not what you want.

This matter will be discussed at the advisor's first meeting with the team and will come up frequently afterward. An investigation may show that the business has to strengthen its management team with new skills. 

The management team will learn about and comprehend these demands with the advisor's assistance.

Share

  • Share the wealth 

The management team should think about giving firm employees stock. Alternatively, a combination of performance-based and time-based vesting options might be used to accomplish this. 

A shared reward scheme will be an effective motivator for the company's success. Based on effective incentive systems they have observed in previous agreements, an adviser can offer insights.

  • Keep it quiet

The management team shouldn't reveal their plans to the public since they don't want the information to leak. This might divert the attention of the company's essential stakeholders and start an auction that results in the management team losing the asset. 

Advisors are accustomed to operating in certain circumstances. They may assist management by disseminating information with great care and effectiveness.

Examples of an MBO

Example

  • General example

The promoter of Corporation XYZ, a publicly traded company, controls 60% of the company's shares, with the remaining 40% being sold on the open market.

The business intended to buy out the management. According to the strategy, the management of XYZ Ltd. makes plans to buy fair shares from the general public to have a controlling stake of around 51% of the total shares of the firm.

The management may seek a bank, financial capitalist, or venture capitalist to assist them in funding and setting up the acquisition of the target firm.

  • Real-life examples

When a business wants to go private to increase its profitability and prospects, MBOs frequently take place. 

A well-known management buyout occurred in 2013 when Michael Dell, the creator of the computer business of the same name, spent $25 billion to take it private with the backing of a private equity group. 

Dell

The MBO left Michael Dell as the third-largest computer maker in the world, with a 75% ownership share in the business.

Dell's projected market value in 2018 was $70 billion, almost double its MBO value. In December of the same year, it re-entered the public eye.

A management buyout that took place more recently was finished in November 2020. 

Following a bankruptcy case in 2019 that placed it in the hands of a collection of private equity companies and hedge funds, Fuse Media CEO Miguel Roggero oversaw an MBO of his business with undisclosed terms.

During the same month, Michael Line, a former PricewaterhouseCoopers director who oversaw eBAM, PwC's fintech branch, managed an MBO. After the takeover, supported by two private equity companies, the business changed its name to LikeZero.

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Researched and Authored by Hitesh Sarda I LinkedIn 

Reviewed and Edited by Aditya Salunke I LinkedIn

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