A Management Buyout (MBO) – What You Need to Know

Following the impact of Covid-19, many business owners are proactively considering their future succession plans. One of the effects of the pandemic is that business owners have been compelled to step back and evaluate their wider life outlook.

A business will be the most valuable part of an entrepreneur’s overall wealth. This value will typically be locked within the business. Despite the uncertain economic outlook and post pandemic, several business owners are aware this wealth is at risk. That’s where a Management Buyout (MBO) comes in.

Certain businesses will typically be passed to the next generation, whether that is family or the next management team. Increasingly, we see business owners focusing on their ‘legacy’, with a desire to see their company and their employees succeed and thrive in the future. This would indeed be a great fit for an MBO.

Below, we will explore what an MBO is, its considerations, funding options, and common concerns.

What is an MBO?

An MBO is a transaction whereby typically a group of individuals within the current management team of a business acquire the shares of the existing shareholders. Businesses often borrow money to pay for these transactions. Since the existing management team already know the business well, this is often the smoothest type of succession and will typically result in a faster and easier transition.

What factors should I consider?

When considering an MBO, thought must be given to the funding landscape and the existing management team. The key element to any successful MBO is the quality of the management team supporting the current business owner. If this team is incomplete or does not have credibility, it is likely to be a non-starter.

In cases where a management team appears insufficient or lacking credibility, it is advisable to strengthen these teams before an MBO. An external candidate may be an option to consider. The key to the above is to plan for an MBO in advance. This means bringing in the required skill sets to enable you as a business owner to seamlessly extract yourself.

Funding for MBOs

Typically, the High Street banks would have been your first option with respect to funding the transaction, however we have seen a number of banks (in the main) pull back from funding in the SME sector.

This, in turn, has provided an opportunity for the so-called ‘alternative’ funders to capitalise on this opportunity to become the mainstream funding source for the changing needs within the SME sector. The impact is a higher availability of funding with more flexible funding structures than had previously been available. However, the underlying price point has increased.

This price point increase should not overly concern business owners looking to structure a transaction. This is a relatively modest cost considering the increase in flexibility and higher amount of funding that these alternative funders can put into the market to fund MBO’s.

What are typical concerns for MBO teams?

A concern for many MBO teams can be the potential debt burden. However, it’s important to point out that it’s unusual for the full share purchase amount to be complete upfront. Deals often feature a structure to avoid overstretching the businesses’ finances. Most deals have an ‘up front’ payment and a ‘deferred’ element. This means additional funds that generate from the businesses’ ongoing activities are given over a mutual timeframe.

An MBO structure may also be advantageous in situations where business owners perceive greater risks. For example, business owners may look at valuable assets (typically a freehold property) that has intrinsic value outside of the business. As well as adding trading value, ring-fencing this asset could protect it from the failure of an MBO transaction by transferring it into personal ownership.

This would leave the management team to acquire the trading entity at a lower valuation and potentially de-risk both parties. There would be no reason why both parties could not enter into an option agreement around the freehold property. This allows the management team to acquire this property in the future once there is a reduction in risk level.

Does this sound like the ideal situation for your business? Are you interested but not sure if it’s right or you? If you would like to discuss further, please contact our Partner, Derek Armstrong, who would be happy to help.

Want to keep up to date with what we are up to? Follow us on LinkedIn.