What makes MBOs work?

DANIEL DICKSON of PKF explores how management buy-outs need to work in the interests of vendors and purchasers

IN EVER-increasing numbers, shareholders are looking to their management teams as a credible buyer for their businesses.

In the last six months, corporate finance activity levels have increased significantly and nearly half of the deals that we have completed have been management buy-outs (MBOs).

If you are part of a successful management team and are keen to acquire the company you are running or, alternatively, you are a shareholder who wants to give the management a shot at buying the business, it is vital that you understand how and why MBOs work.

At its simplest, an MBO allows a management team to benefit directly from its own success, enabling management to share in any increase in the company’s value that they help to create. An MBO may also be a way for shareholders to realise the value in their business in a more confidential way than selling to a trade buyer.

With the right structuring, advice and use of assets, it is possible for a management team to create a compelling offer, to rival that of a trade buyer, which will make the shareholders take note.

A successful transaction requires the management team to stump up some money but this equity alone will not fund the deal. External finance will be required and this typically comes from three sources:

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n Bank debt – The challenge with a management buy-out is to leverage the business with the right amount of debt without leaving the business exposed. By analysing the assets and the quality of the business, and stress-testing the forecasts, your advisers will help you to understand what level of debt the business can take on.

n Vendor deferral – There can often be a funding gap in MBOs between the availability of bank finance and the agreed price. Assuming the shareholders will not reduce their price expectations, this can be addressed in two ways, the use of vendor deferral and the use of private equity. Vendor deferral involves the shareholders waiting for some of their money – typically by putting in place a loan with the new company over a period of months or years. With interest rates currently being at an all time low, this can be an attractive option to vendors as a higher level of interest can be paid than would be earned with the money in the bank.

n Private equity – Increasingly, private equity firms are backing management teams and plugging the funding gap by taking a minority or majority equity stake in target businesses. Private equity firms seek quality businesses with good cash flows and the prospect of growth. Above all, they seek high quality and complete management teams.

With good preparation, sound advice and an understanding of the issues, it is possible for both the seller and the management team to realise value from an MBO.