Considering a Management Buy Out? Here’s What You Need to Know

April 12, 2018 Management Buy Out

There are all sorts of reasons why a company’s management team may decide to explore buying their business. Sometimes it is a case of the owners putting a business up for sale and the leadership team either deciding they would prefer to run it themselves than work under new ownership or being offered first refusal.

Sometimes a management buy out (“MBO”) is triggered by a company getting into difficulty, and employees seeking to recover it from administration. On other occasions, MBOs take place because of dissatisfaction with current owners, or a feeling from the management team that they would do a better job if they had complete control.

In any of these circumstances, the decision to launch an MBO requires careful consideration, and the execution careful planning. Here are some key things to weigh up beforehand.

Financing an MBO

The most important part of any business takeover is how it is funded. Some still mistakenly believe that the people involved join together and pool resources to gather the required amount.

However, in the vast majority of cases, the management team will not raise the full funding from their own personal means. Even for a moderately sized business, this would probably not be possible. And if the business was small enough to make this theoretically viable, it would still probably represent too much personal risk for the management team.

The team behind an MBO will usually raise a percentage of the total funding requested between them.  The rest of the small capital will be raised from third party sources:

  • Private equity or venture capital
  • Bank debt
  • Invoice based or asset based finance
  • Vendor deferred consideration, where the vendor agrees to a proportion of the consideration being delayed, sometimes subject to future profit levels

Avoiding the pitfalls

An MBO may be the buyers’ first venture into business ownership. As for all new entrepreneurs, it can be a steep learning curve, even if you have a very strong inside knowledge of the business.

Choosing a method of financing the deal is the first potential pitfall as the different options available all have different merits and weaknesses, and picking the right combination for your circumstances can be tricky. To avoid being stuck with unmanageable debt, or handing over too much control for a third party investor, get professional advice.

Another potential pitfall is not paying due care and attention to the practicalities of becoming a shareholder in the business. This requires good communication between partners, and a willingness to agree a long list of seemingly hypothetical scenarios – what happens if someone wants to sell a stake, what happens if someone dies, what happens if the business fails. Some or all of these will happen one day, and there should be clarity on them using a Shareholders Agreement.

At the same time, it is easy for managers to become too concerned with their role as a shareholder and start to view the business purely in terms of their own investment. This will end up leading to conflict, as everyone competes based on their own self-interest. Be strict in maintaining a management structure – your loyalty is first and foremost as an employee to the company.

Contact our corporate finance team for more advice on considering and planning a management buy-out.