Management buyouts for manufacturers: a simple guide
Management buyouts (MBOs) are common in the manufacturing sector, particularly in those businesses where employees successfully rise through the ranks to become managers, staying with one company for many years.
Such loyalty can mean that management teams in these businesses stay in situ for many years, making money for founding owners who often take a backseat and allow managers to run the business with little hands-on supervision.
But there always comes a point when owners are ready to exit the business and / or management teams feel they are ready to step up and become owners. But where do they start? And how will owners react to an MBO approach?
In this simple guide, Stephen Gregson, corporate finance director at Moore and Smalley, and Ginni Cooper, head of the firm’s manufacturing team, give a beginners guide to MBOs.
1. In a nutshell, what is an MBO? How does it differ from a trade sale or acquisition? Why do vendors and management teams want to do MBOs?
Put simply, a management buyout (MBO) is when the members of the management team acquire at least a majority stake in the business for which they work. It could be that the management team acquires 100 per cent of the shares in the business; but it would not be a management buyout if the management team held a minority share.
The make-up of the management team can also give rise to different variations on the theme. It is not unusual for a management team to need some external management resource in order to ensure the team possesses the right skills and experience. Hence there could be a buy-in candidate also involved. In these instances the deal might be called a BIMBO (buy-in management buyout).
An MBO differs from a trade sale in principally two respects. Obviously, the acquirer is different. More importantly, certainly from the seller’s perspective, is the typical funding of an MBO. The normal MBO funding structure would have a proportion of consideration deferred (payable in the future). There may also be elements which are contingent upon the future performance of the business (this is called an earn-out) and, increasingly common, it may be that the owner retains a minority share in the business going forward. All of these aspects are typically employed because management teams usually find it harder to raise the required funding than trade buyers, hence, in an MBO situation, there is usually less cash available to be paid to the vendor on completion.
Management teams usually want to do an MBO because they want to be masters, or mistresses, of their own destiny and often have a belief that they can run the business better than the current owners. Owners might want to carry out an MBO because they feel a sense of duty to their management team and they want to allow them the chance to own the business and build up value for themselves. Also it can allow owners ‘two bites of the cherry’ if they retain a minority stake in the business because they may see the value of this increase if the management team can successfully increase the value of the business.
2.How are MBOs usually initiated? What sort of personal and commercial sensitivities must be dealt with or resolved?
MBOs can either be initiated by management or by the owners. It usually does require a certain degree of trust and goodwill to exist already between owner and management team for management teams to feel confident enough to initiate the process. There will be understandable concerns on the part of management as to how the owner(s) might react. Will they see management’s desire to effect an MBO as a sign of disloyalty, for instance?
Another potentially thorny issue can be the valuation of the business. The vendor might have a suspicion that if management have been planning to try and carry out an MBO, then perhaps management have not been building the business as robustly as they might have been expected to do. This is on the basis that if they increase the profitability of the business then this only serves to make it more expensive for them to carry out an MBO.
3. What are the routes to finance for an MBO? What are the pros and cons of each?
Questions of funding a transaction depend to a large degree on the specific characteristics of the business being acquired and the financial wherewithal of the buyer(s). If the business has good growth prospects then it may be of interest to a private equity funder. Hence, the MBO team could look to secure private equity finance.
This can be tremendously helpful in strengthening the capital base of the business and providing it with the funds to grow, but it does mean that the funder shares in the ownership of the business. Also it will usually have the final say on when a sale takes place and may also want a reasonably active role on the board of directors.
There may be the ability to use the assets in the business as security to raise debt funding. Thus no equity is surrendered by the management team. However, this debt will need to be serviced. It could prove difficult to do so if the business suffers a downturn. Additionally it may be a condition of some debt packages that the MBO team has to provide a personal guarantee that the debt will be repaid. This means that the management team is theoretically carrying significant risks.
Usually, a key component of any MBO funding package is ‘friends and family’. The potential downsides here are that unless your friends and family are particularly wealthy, the total amount raised this way is unlikely to be a significant amount in the context of the overall deal. It also runs the
risk of blurring any dividing lines individuals may have between the work and non-work aspects of their lives.
4. What are the main issues of the MBO process itself? (eg raising funds, due diligence, maintaining business performance during the negotiations)
Principally, the main issues are the same as with any sale. Once the price has been agreed, can the buyers raise the funds on acceptable terms and, secondly, can the performance of the business be maintained during the sale process?
Typically you would expect that the due diligence required on an MBO would be lighter than on a trade sale. The reason for this is that the MBO team should pretty much know the business inside out already. However, depending upon the funding sources for the MBO it may be that funders require detailed due diligence, particularly on the members of the management team themselves. This applies whether the funder is providing debt or equity.
Funders all say that they back individuals rather than backing a business. A great business is all well and good; but it can rapidly become less than great if it is mismanaged.
5. What are the rewards of a successful MBO?
For the management team they will include independence, freedom of action and the potential for future financial reward on a subsequent sale.
For the vendor they will receive an acceptable value for their shares; have the satisfaction of feeling they ‘did the right thing’ by allowing loyal employees to own and benefit from the business and, possibly, they will have been able to ‘have their cake and eat it’ by virtue of retaining a minority stake in the business.