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How and why to do an MBO

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Although still far short of the record £47.3bn achieved in 2007, it was a clear indication that the nascent economic recovery was beginning to stir the imaginations of lenders, private equity firms and ambitious British firms and businessmen/women.

2015 could see those figures rise again buoyed by clear signs that banks are looking to increase lending, alternative finance providers continue to grow in strength and businesses dust down plans to capitalise on improving confidence.

But what exactly is an management buyout (MBO)? How do they work and when should a growing business put one in place?

An MBO is simply where the owner of a business sells out to its existing management team rather than to an outside party such as a trade rival.

The motivation behind an owner’s decision might be retirement or looking to cash-in on perhaps 20 or 30 years of hard work of growing the business or even an itching to try something different and set up another business from scratch.

There is certainly a strong likelihood that the rising growth of MBOs is in part down to owners putting off these life-changing decisions during the uncertainty of the recession and now feeling much more confident about making the move.

The benefits for the owner of dealing with his management team include the likelihood of a quicker sale than could be achieved elsewhere, familiarity with the team and therefore a less onerous negotiating period and reduced warranties and indemnities.

An owner may also feel assured that the team, most of whom he will have recruited himself, are trusted to protect his “baby”, staff’s job security and ensure it will continue to succeed.

From the perspective of the management team they are often given the nod by the owner to start preparing for an MBO. Perhaps he has indicated to them that an MBO would be his preferred exit in say three or four years’ time.

However in other cases it can be frostier. A management team might independently decide to go for an MBO perhaps thinking the owner is dragging the business down, has a dearth of new ideas and no future strategy.

Read more about the business strategy:

Their first step should be to get a team together and ensure that everyone is on the same page and eager to go ahead. Look at the breadth of the team – it will need to consist of an MD, sales, operations and finance director.

Are you happy with the quality, the balance and the experience? Is there scope to bring in someone from outside with more or different skills?

The next stage is to carry out a feasibility assessment working in tandem with a corporate finance advisor. This would iron out the structure of any transaction and give the team time to produce a detailed profit and loss, balance sheet and cashflow projection for at least the next three years.

The advisor will help you come to a valuation of the business based on its size, sector, growth prospects and the future cashflow.

Your advisor can then be the one to begin negotiations with the owner. The management team should also be involved here and it is vital that the talks remain friendly and professional – remember if no agreement can be reached you will soon be returning to your management position. No point making an enemy of the boss.

Once terms have been agreed with the vendor, get a head of terms agreement and an exclusivity period for you to get the finance together.

A business plan, including management strategy, must be drawn up at this stage as this will be the key to finding investors to back the MBO. Put simply you have to show your new business vision will create profits and give you enough cash to repay the capital and interest of your new funding structure.

Bearing this in mind it is best to launch your MBO when your business is performing well – you will struggle to attract any investors if your recent financial track-record is poor. Timing therefore is vitally important.

Funders are also interested in the barriers to entry in your sector, competition and the strength and background of the management team. They are not just backing the business they are backing people and often funders will insist on changes to key positions such as MD or FD.

Once the funders, which are often a private equity firm or a bank, have been found they will then carry out due diligence on the business.

The financing is usually a combination of debt and equity – the term used in the industry is “skin in the game”. The theory being that the management team after putting some of their own money in, will be extra motivated to make the new venture work.

You have to consider that a PE firm will be looking for a stake, a good return and an exit from your business within the next four or five years. Also whoever the financier the business will no doubt be carrying much more debt than it was previously.

The next stage is for your legal team to sift through the structure of the deal and negotiate with the owner over issues such as warranties. Legal documents are then signed by all parties concerned.

The process can be expensive and time consuming – on average between four and six onths to complete. It can also be stressful particularly if you have to do the planning and costing outside of your normal working hours.

But given their equity stakes in the business it is also a process which gives managers a great opportunity to make life-changing returns if the firm delivers on its profits and growth hopes.

It also gives an owner, some of whom retain stakes, to make their own healthy return from their years of graft and sacrifice.

Image: Shutterstock

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