A management buy-out (“MBO”) involves the acquisition of a company by its management team, usually combined with the raising of external finance to fund the purchase. The common motivation for the management team is the opportunity to take ownership of the business in which they have worked and so create the opportunity to build and then realise a capital gain themselves.
THERE ARE SEVERAL DIFFERENT COMMON VARIATIONS IN A BUY- OUT
MBI – a management buy-in which involves the acquisition of a company by a management team that is not currently within the company. This type of transaction is considered riskier by many funders as the team do not benefit from inside knowledge of the business. To mitigate this risk for funders, the management team will usually be required to invest a higher proportion of the consideration themselves and have vast experience in the particular sector and prior experience of corporate transactions.
BIMBO – a buy-in-management buy-out which is a combination of an MBO and MBI. In this situation the management team comprises some members of the existing management team but is bolstered by one or more external members. This helps reduce the risk of an MBI as there are members of the team on the inside but it also helps fill gaps in the experience and skill set of the existing team (possibly due to the CEO being the person selling, bringing in a full time or more experienced finance director, or due to some members of the existing team wishing to retire).
IBO – an institutional buy-out where the private equity house leads the transaction makes the acquisition and then incentivises the management team by offering it the opportunity to subscribe for shares. This is most prevalent in larger transactions where the seller’s adviser approaches the private equity house directly and creates an auction process. The management team may be very important to the ongoing business in which case the private equity house will want the team to be part of the final deal but it is also possible that management are less critical in a large business and the private equity house may replace some or all of them. Typically, the management team will have a smaller equity stake but, given the business is likely to be larger, there is still the opportunity for the management team to make a significant capital gain.
Our team has extensive experience in MBOs, MBIs, BIMBOs and IBOs including having worked for private equity houses, investing as principle, and has advised on many completed transactions.
We have extensive private equity and banking relationships and are able to identify the right partners for you based on the size of transaction and the individual characteristics of your business.
Structuring a deal with the optimal balance of debt, equity and management commitment is something that comes from many years of experience. We explain below in more detail how we assist management teams on MBOs. In the case of an MBI, we can also bring our acquisition research skills to bear in order to help find the right opportunity to start with.
In the case of an IBO, our role is often focused on advising the management team on the terms offered for its investment and possibly the Newco that has been formed to make the acquisition on the impact of the overall funding structure but the private equity house will normally source its own debt and agree the deal directly with the vendor. The role of advising the management team is very important in making sure that the team gets the right equity deal with the private equity house. Our role will involve modelling the terms for management and negotiating them with the private equity funder – including the quantum of their investment, their equity stake in comparison to that of the private equity house, performance ratchets, etc. Our role often extends to looking at various funding elements on behalf of Newco including covenants, financial modelling, etc as required.
THE MBO OPPORTUNITY
The window of opportunity for an MBO will not present itself very often. You may be fortunate enough to be approached by the owner of the business but it is an option often overlooked and so you should be alert for signs that the current owner may have a motive to sell. In a privately owned business this may be as simple as a lack of family succession and indications that the owner wishes to retire; a wish by shareholders to de-risk by realising cash; or a desire by some (but not necessarily all) shareholders to exit. Alternatively you may have already succeeded the owner in the management role and, having driven the development of the business for a period of time, feel you deserve the opportunity to buy it.
If your company forms part of a group, you should consider the wider group strategy to determine the future of your business. Key indicators include a change in strategic direction which makes the activities of your business non-core, sometimes manifesting itself through a lack of investment, or liquidity problems within the parent company.
Once the initial MBO interest has been established, it is essential for the management team to consult an experienced and expert adviser.
When advising on or leading negotiations with the selling shareholders an MBO requires similar skills to that of any corporate acquisition. However, in an MBO situation there are existing relationships to consider and, importantly, preserve, particularly in the event that a transaction is not possible for any reason. As the management team’s adviser we are able to manage the process sensitively while retaining a robust position on our client’s behalf.
One major area of difference to a corporate acquisition is the level of preparation required in terms of a business plan supported by a detailed financial forecast model. The business plan needs to describe the business, its market and the investment opportunity in sufficient detail to allow funders to assess the potential and decide whether to pursue the opportunity. We will advise you and assist you in this.
HOW ARE MBOs STRUCTURED AND FUNDED?
Often managers do not have the personal financial resources to purchase the business which employs them and so the finance normally takes the form of private equity, bank debt or both, but other sources are available, including the selling shareholders providing funding through deferred payments.
The management team is expected to show its commitment by investing a sum relevant to personal circumstances but that is normally a fraction of the total funds required to buy the business.
A variation on the MBO theme is for shareholders to work with advisers to assess the potential for an MBO before they introduce the idea to their management team. By gaining an understanding of likely valuation and the availability of finance they can assess the merits of starting on such a track and whether there may be a need to provide some of the funding themselves before initiating a process.
If an MBO involves a public company then our team combines its knowledge of acquisitions and structuring funding solutions with a detailed understanding of the rules and regulations involved for making an offer for the company under the Takeover Code. In such circumstances it is vital that an early assessment is made of the most appropriate route to take in order to minimise the transaction risk that is often associated with “public-to-private” transactions. With many years of investment banking experience and numerous recently completed transactions our team provides City-quality advice.
HOW CAN WE HELP?
Managers are unlikely to be involved in more than one MBO in their lives and appropriate advice at an early stage is sensible when embarking on such a complex and sophisticated transaction. In addition, the management team will find itself under immense pressure and severe time constraints during the process, as well as having to fulfil its continuing management responsibilities. We will be able to assess your chances of success at the outset and so save you a lot of time and energy, as well as disappointment, if the chance is low.
Our role in an MBO initially involves assessing the aims and objectives of the current owners and determining a valuation range within which an MBO would be viable. At this early stage we will advise on the likelihood of obtaining funding and from which sources and on what terms. This will require us to gain a thorough understanding of the business and your plans for the future, together with putting together some financial forecasts to help assess what may be possible. It is important that we devise a structure that delivers the objectives of management, funders and sellers while providing sufficient headroom to cope with identified sensitivities.
We will typically lead negotiations with the seller on your behalf due to our experience on what is possible from a funding perspective but also, importantly, to maintain a buffer between you and your current employers. It is important to remember that if the MBO doesn’t happen then you will need to carry on working with the owners and, if you are a director of the company, you also have certain fiduciary obligations and duties.
Once an outline deal has been agreed with the seller we can bring our years of experience of reviewing business plans to bear to help you create a clear and concise document that can be shared with the funding audience. As part of this process we will also work with you to prepare the detailed financial projections that will accompany the business plan.
A “warm” introduction to funders and a professionally prepared business plan makes the introduction far easier and your proposal is likely to attract greater interest with more relevant funders.
When indicative offers are received we will again use our experience to assess the options and negotiate terms on your behalf while there is competitive tension between competing funders. Terms may include repayment profiles, equity stakes, rights attracting to the funding, financial covenants, and others depending on the type of funding. Remember that whilst you may not have been through this before, we have.
Once preferred funders have been selected we will work with you and the funders to plan their detailed due diligence requirements, which will include identifying specific risk areas, selecting professional advisers and agreeing their terms of reference, and managing the process so as not to create unnecessary tension between buyer and seller. As well as financial due diligence, we need to also consider the need for commercial, legal, technical, operational, tax, environmental, pensions, and insurance due diligence. Not every deal requires every aspect especially as you already know the business well due to your existing involvement, something that funders may be able to rely upon.
During this phase the legal process will also commence and we can assist in the appointment of legal advisers and, where appropriate, recommend firms experienced in the size and complexity of the transaction being contemplated and assist with terms of reference.
In the final phase of an MBO we work closely with all of your advisers and funders, assisting with the commercial aspects of the deal as they impact on the legal agreements and liaising with you and your legal advisers on apportioning risks between buyer and seller through negotiation of warranties and indemnities.
TIMESCALES AND COSTS
An MBO is a complex transaction involving numerous parties, often with conflicting needs despite an overall common goal. Consequently, the time taken to complete an MBO varies significantly.
It is likely that the transaction will take between three and six months to complete although it can extend further if funders require more time to assess the business.
Of course, with a degree of pragmatism and willingness it is possible to complete a deal much more quickly, within a matter of weeks, particularly if the funding takes the form of asset-based lending and there is no private equity involvement. This is because the asset-based lender’s principle focus is on the security value of the assets rather than on the dynamics of the business, its markets and management.
In terms of the cost of an MBO process, as a rough guide this could amount to between 5% and 10% of the deal value depending on the size of the deal and the sources of finance. We are comfortable participating in flexible fee structures involving sharing the risk and reward of the transaction reaching a successful conclusion. We can also take equity in the deal as part of our remuneration and, furthermore, we can invest our own money alongside the management team thus demonstrating our belief in the structure and terms of the transaction as well as the longer term prospects.