When it comes to selling a business, there are a number of options and management buyout (MBO) is a popular strategy. With existing staff buying their company, business owners are often able to achieve better business value. The transition into new ownership can also go more smoothly and without many of the negative emotions that may accompany a sale of a business in an open market or to a competitor.
This exhaustive guide will show how to finance and complete an MBO in order to achieve the best deal for all concerned. The tips and examples given will also show some strategies that will ensure the business involved in MBO can operate smoothly and has a good strategy for growth once ownership is handed over.
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What is a management buyout?
A management buyout (MBO) is one way for business owners to sell their business – and an alternative to a traditional open market or trade sale. It involves some of the existing management, usually directors or senior staff, forming a team and buying business shares from the current owners. In an MBO, the management team takes full control and ownership of the business, and they use their expertise to grow the company and drive it forward.
In addition to this classic type of a management buyout, there are also some variations on the process:
Buy-in management buyout (BIMBO) is where an outsider is brought into the management team to fill a skills gap, before the entire team buy the business together.
Management buy-in (MBI) is where a complete management team forms to buy the business, none of whom have worked for the business before that point.
Employee ownership is where all staff come together to jointly own the business. A well-known example of this structure is John Lewis and Waitrose.
Openness and trust in MBO deals
There are two common situations where management buyouts (MBOs) may occur. For large corporations, it is a common exit strategy to sell off divisions that are not part of their core business. When it comes to private small or medium size businesses, retirement or a change in life circumstances may prompt this type of sale.
Whatever the situation above, management buyout promotes openness, teamwork and conscious preparation across the entire business. The process allows the business owner to set common goals with the MBO team. They then all work together to achieve those goals to make the sale more attractive to all parties involved.
MBO preparation and planning is different to an open market sale which is conducted in secrecy. In the latter, the business owner will often be the only person knowing their own intentions to sell. This means they are restricted in terms of planning for the future of the business beyond the transaction and they risk existing staff being negatively impacted by the sale.
As a business sale is one of the most stressful things you can do in life, a clear advantage of an MBO is shared responsibility and effort. The business owner and the MBO team usually know one another well which helps ensure a trusting environment to do business in.
Confidentiality is a related subject. With an MBO, the buyers already know the business inside and out. This includes the customers, the suppliers and all the trade secrets. The information is safe with the MBO team. There is no need to sign additional NDAs or risk revealing critical trading information to potential competitors – as would be the case in a trade sale. Management buyout prevents any potential breaches of trust that could happen in more traditional business sales.
Management buyout planning
Additionally, all team involvement should be underpinned by careful planning.
A key part of this plan is for the owner to set a clear expectation of the value they wish to sell for. Exit strategy will involve supplementing this sum and a blueprint for sharing the excess with the MBO team.
Over-shooting the value target during the preparation process provides a surplus that the MBO team can use as their contribution towards raising finance.
A good plan will set out how to utilise existing assets, how to document and automate operations and how to create additional revenue streams in order to reach the desired financial goal. All this should be scheduled with clear milestones and deadlines. If the business owners select the right team members and set the deal correctly, an MBO can bring cohesion to drive growth and hit goals.
As a side benefit, a business with clear growth strategy and business plan will find it easier to raise any necessary finance. If that same plan rewards existing team members as they reach their exit goals, then that common goal will drive the business forward.
The longer the business is able to afford for the process, the bigger the returns are likely to be. Typically, a period of 3-5 years of preparation is preferred. If the business owner is looking to complete a sale faster, considerations might need to be taken into account.
Success potential of MBO deals
An important consideration for any business sale is how likely it is to happen. Business owners desperately went to prevent bankruptcy or liquidation – so ensuring that a sale can go ahead is critical.
Sadly, as much as 70% of businesses listed in the open market are not saleable and 48% won’t sell (according to IBBA – International Business Brokers Association). There are no comparable figures on MBOs because those conversations happen behind closed doors. However, speaking from experience as business brokers who supported management buyouts over the past 10 years in business, we have seen that MBOs are likely to be more successful. This is due to the fact that MBOs involve working together towards a common goal by a team of dedicated people that already have the experience of working collectively.
Management buyout financing
MBOs tend to happen in businesses that support staff hierarchy. It follows that the sums involved are not generally available in one person’s savings account.
Management buyouts often involve a combination of finance options to make sure that enough money can be secured to complete the deal.
It is expected that the MBO team will cover at least part of the deal using their personal funds. This shows commitment to the deal and provides confidence to additional lenders.
The management buyout team will usually require finance. Banks usually finance these types of sales keenly as they involve less risk than an open market sale. They may require less personal contribution from an MBO team than from an outside buyer so long as they have a proven track record in the business and in the industry. This is demonstrated best if the owner takes a step back and lets the MBO team run the business before sale. The owner may reduce their hours, take semi-retirement or take an extended holiday to demonstrate this.
If the value is not covered by the above sources, the business owner may need to step in and provide the additional funds needed. These will be repaid over a period of time as the business continues operating. It’s not a preferred option for the vendor as they are required to hand over the keys to the business, whilst still being required to lend money to the MBO team – making it a potentially risky option.
Management buyout examples
To understand the considerations and planning that goes into a management buyout deal, below are a few examples that show the process in action. These are from businesses that we worked with to complete their MBO processes as well as ones that are still on their journey to business exit.
Achieve greater funding flexibility by building business value beyond target
Steve and John own an £8m turnover maintenance business and they intend to sell it for £5m after 5 years (current value is £2m).
Before we started working with them, they have already appointed and built a loyal and qualified management team. This allows them to act in the background and reduces risks involved. Their appointed MD was tasked with building a business growth plan which would make their £5m exit value achievable. This is when we were contacted.
We actively supported the MD and the rest of the team to develop their growth plan. We quickly saw additional opportunities that will help them exceed their £5m target. We spotted them by using a Value Builder assessment, our tool designed to assess the value of a business and identify how it can be improved. This will allow the MBO team further flexibility on funding when it comes to buying the business 5 years from now.
Create a reward system for the MBO team to incentivise them to grow more
Raz is looking to exit his service business in 5 years for £500k. He has two key members of staff, who he would like to buy the business. The current value is around £250k. The plan is build further cohesion in the team by issuing growth shares. These will award 60% of the value of the business above £500k to the MBO team, with the current owner receiving just 40%.
By working together and rewarding the two MBO team members this way, the plan is to actually target a value around £750k. In reality, this will gift the new MBO team a contribution from within the business of £150k. Raz gets £600k. The extra £100k provides flexibility for both sides should the terms of the deal need to flex closer to the exit. This means that if the growth strategy doesn’t go exactly to plan and targets aren’t hit, having aimed for a higher target to begin with may mean a lower expectation is still achieved.
Vendors can provide a loan to cover a shortfall but risk not getting the full money owed
On a recently completed MBO in the engineering sector, vendors sold for £2m, which was the value they were seeking. However, because they did not plan ahead with enough time, cash sources were limited. We helped plan and secure the collective funding to make sure the sale can go ahead.
Their management team had a £300k contribution from their personal resources. A further £1m approved lending came from the bank.
That still left a £700k shortfall. The vendors provided the balance, partly as a deferred payment (a loan), and partly on an earn-out basis (subject to future business performance). The loan and earn out payments both needed the further approval of the bank because of the security being put in place.
The key risk here to the vendor is that any money they have not received at completion is not guaranteed. A delayed consideration is always at risk of non-payment due to circumstances that simply cannot be anticipated at the time. Plan ahead with as much time as is possible to help build up contributions.
Lack of clarity around tax avoidance could mean your money is withheld for a period of time
Acting as advisors for an MBO team in the manufacturing sector, it became clear there was an important tax component that would affect the deal.
The vendors had undertaken a legal but aggressive approach to personal tax planning before we got involved. Because of this, the lender in the deal insisted the vendors left over £500k in an escrow account, until the matter was cleared by the revenue. Unfortunately, this represented half of the value paid at completion, which makes it a significant amount. What’s more, the revenue have 7 years to investigate tax issues so it will take time for the business owners to receive the full amount they agreed.
Early planning and better tax transparency ahead of time could have prevented these issues.
Business value can be built up in different ways to achieve targets
We are currently advising three joint owners on their exit from a wholesale business. Current goodwill value is around £1.75m and they wish to sell the company for £4m within 3 years.
After looking at different aspects of the business, we found a few ways that will mean the deal can be achieved.
Firstly, there is a property in the company with a value of £1m. This can be moved out and into personal ownership before or at the point of sale – pushing overall value to £2.75m. This means there is now £1.25m left to secure.
At existing performance, retained profits will be £750k in the next 3 years. That will effectively be cash added to the company balance sheet and it means that a further £500k is left to secure.
Finally, working on the business specifically to improve value would add an anticipated £500k to the overall value. This will include rounding out the MBO team to ensure the relevant key skills are in place, allowing the current business owners to leave on sale.
All this means that the total business value in 3 years will be £4m – the amount that the business owners are seeking.
What’s more, we have set out a shared bonus strategy should the business exceed growth targets. This strategy will benefit the three owners and the MBO team fairly. The bonus could reduce the amount of borrowing required by the team or could provide further cash flow for ongoing growth. For example, achieving 20% growth in sales over 3 years (against last year’s growth of 20%) will add £1m to the value and provide an MBO contribution.
With a strong and stable MBO management team then having been in situ for at least 3 years, securing finance from a bank should be achievable.
With a plan like this, this company has a clear pathway to achieve satisfactory value for its current business owners and coherent programme for business growth and good results for the MBO team.
Management buyout is a lucrative way to ensure enjoyable retirement or ability to pursue hobbies and interests freely after having a business. The key to achieving the business value that will allow you to meet your personal goals is early planning.
With planning, you will be able to grow your business strategically and minimise risks. It will also help you ensure business continuity, so you can see your company develop beyond your ownership.
The first step towards selling your business is a valuation. Check if you’re eligible for a free valuation today (three out of four businesses are).