Management Buy-Out (MBO) & Buy-In (MBI)
A management buyout (MBO) is a corporate finance transaction where the management team of an operating company acquires the business by borrowing money to buy out the current owner(s). An MBO transaction is a type of leveraged buyout (LBO) and can sometimes be referred to as a leveraged management buyout (LMBO).
In an MBO transaction, the management team believes they can use their expertise to grow the business, improve its operations, and generate a return on their investment. The transactions typically occur when the owner-founder is looking to retire or a majority shareholder wants out.
Lenders often like financing management buyouts because they ensure continuity of the business’ operations and executive management team. The transition often sits well with customers and clients of the business, as they can expect the quality of service to continue.
Why a Management Buyout?
- Management buyouts are preferred by large companies seeking the sale of unimportant divisions or owners of private businesses who choose to withdraw.
- They are undertaken by management teams because they want to get the financial incentive for the company’s potential growth more explicitly than they can otherwise do so as employees.
- Business owners find management buyouts appealing, as they can be assured of the commitment of the management team and that the team will provide downside protection against negative press.
How to Approach a Management Buyout?
If you’re part of the management team that wants to buy out the current owner(s), then you’ll need to be thoughtful in your approach (or you may be approached by the owner).
Put together a thoughtful proposal outlining why you want to buy the business, what you think it’s worth, and how you would finance the purchase.
Be sure to do your due diligence, including building a financial model and performing a thorough valuation analysis.
It’s important to know which members of management will participate in the buyout and which members will not. From there you will need to choose a fair way of distributing equity in the transaction.
How to Finance an MBO (or LMBO)?
Generally, substantial funding is required for management buyouts. The financing for management buyouts can come from the following sources:
1. Debt financing
A company’s management does not necessarily have the resources at its fingertips to buy the business itself. One of the primary options is to borrow from a bank. However, banks consider management buyouts as too risky, and hence may not be willing to take the risk.
Management teams are usually expected to spend a significant sum of capital, depending on the source of funding or the bank’s determination of the management team’s resources. Then, the bank lends the remaining portion of the amount required for the buyout.
2. Seller/Owner financing
In certain cases, the seller may agree to finance the buyout through a note, which is amortized over the loan period. The price charged at the time of sale would be nominal, with the real amount being charged out of the company’s earnings over the following years.
3. Private equity financing
If a bank is reluctant to lend, the management may usually look to private equity funds to finance most buyouts. Private equity funds may lend capital in exchange for a proportion of the company’s shares, though the management will also be given a loan. The private equity firms may require the managers to invest as much as they can afford to tie-in the vested interest of the managers with the company’s success.
4. Mezzanine financing
Mezzanine financing, a combination of debt and equity, will enhance the equity investment of a management team by pooling certain debt financing and equity financing features without ownership dilution.
Top 10 Things to Consider When Planning a Management Buyout
Here are some of the most important points to consider when planning an MBO:
- Research the feasibility of the transaction
- Be open and transparent with executives and shareholders
- Cut key employees in on the deal (share the equity)
- Formulate a strong employee and customer retention plan
- Develop a thorough understanding of the value of the business (financial modeling and valuation)
- Get your financing all lined up
- Don’t get hostile, remain friendly
- Design a well-thought-out shareholders agreement
- Keep the buyout low key until the deal is signed
- Don’t neglect the operations of the business while working on the deal
Want to read more?
The MBO Guide for