Considering a Management Buyout (MBO)?
– Part 3 of a 5 Part Series on MBOs

 

MBO Benefits

An MBO is attractive to both seller and management for several reasons.  Management gains independence and autonomy and an opportunity to influence the future direction of the company with the prospect of significant capital gains.  There are also strong reasons why an MBO can be attractive to the seller.  An MBO can often be realized more rapidly than an external sale.  The fact that management already knows the business shortens the initial stages of the deal.  Speed can be a real competitive advantage to the seller and also means less disruption for the business and less uncertainty for the organization and market alike.  With an MBO there is no need to provide confidential information to competitors who might use it to enhance their competitive position.  Familiarity can also be important where the seller may wish to have a continuing relationship with the business and may feel more confident dealing with the existing management because there is  an established element of trust.

An MBO can be structured to allow the former owner to retain a minority stake in the company. This provides ongoing involvement and exposure to future upward potential.  In an external sale this is less likely.  An ongoing interest may also provide “insurance” to cover the seller’s fears of underselling the business.  The management team is likely to have the backing of the organization because all of the stakeholders know them and know they will keep the company and its culture intact while perhaps most importantly preserving the employee base.

An external sale is often a seller’s first consideration, mostly for purposes of achieving the best price.  However, an MBO can often be just as price competitive for the seller.  While there is the possibility that an external buyer with deep pockets is found who is willing to offer a “strategic premium” to buy the business; however, with innovative deal structuring, the creative use of financing instruments, and the use of leverage, competitive bidding can be achieved via MBO.

The financiers backing the management are also not restricted by issues like “impact on earnings” and goodwill charges.  Existing management knows where to improve profitability, how to manage risks, and can recognize strategic opportunities. Management has a better understanding of the business and therefore any initial offer is less likely to be reduced through the process of the sale.  An MBO bid can therefore be more credible, offering a greater certainty of outcome for the seller in terms of deliverability.  Also, the scope and extent of warranties and indemnities given by the seller in the case of an MBO are generally much lower than in the case of an external sale.

Below is a summarized break down of the advantages and disadvantages of MBOs, versus seeking an external buyer.

Advantages and Disadvantages – MBO vs External Buyer

MBO Advantages

  • Less Marketing. MBO’s do not require the significant marketing required with seeking an
    .00external buyer. Therefore, selling to a management team tends to be quicker and cheaper.
  • MBO contracts are simpler because the management knows the business and minimal
    .00due diligence is required. In addition, the warranties given in an MBO are far less onerous.
    0.0This means that upon closing, the seller is left in a position where he is less likely to be
    0.0burdened with a legacy of promises made pre-sale.
  • In an MBO it is easier to maintain confidentiality and customers and employees are
    0.0unlikely to be concerned by the change in control. The transition will often appear to be
    .00seamless to all parties involved.
  • Companies purchased via an MBO tend to have a higher success rate. Generally
    .00the management teams have the requisite experience and skills within the specific
    .00industry,as well as established key relationships with employees, customers, and suppliers.
    .00This is likely to advantage a seller since it is typically the case that the sale price will
    0.0include an earnout agreement.  The higher the chances that the company will continue
    0.0to thrive post acquisition, the higher the chances that a seller will be able to realize the
    0.0maximum bargained consideration.


MBO Disadvantages

  • The management is likely to be much less experienced in buying a business and considerably
    .00less capitalized. Additionally, experience at the management level does not always translate
    .00into the ability to own a business.  An MBO team will need to ensure it has the right mix of
    0.0skills to lead a business, from sales, HR, finance to operations, and beyond.
  • There will be no synergy savings. This could have a downward pressure on price.
  • Once negotiations commence with a buy out team, if the deal does not proceed to completion
    0.0it can be difficult to go back to “business as usual”.
  • Buyers and sellers will need to think carefully about how a seller will exit the business after sale.
    0.0It is often tricky to negotiate the terms relating to any hand over period as the parties will need
    0.0to strike a balance between possibly retaining the expertise of an outgoing seller with ultimately
    0.0being able to have full control over the business.  If a seller retains an equity stake while an
    .00earnout agreement is in place, a shareholders agreement will be required to govern the relationship
    0.0between the parties during any interim period.


External Buyer Advantages

  • Negotiation without hard feelings. If you are talking to an external buyer and the deal isn’t right
    0.0then pulling out should have no perceptible effect on your business and you have a free hand to
    0.0drive the best deal.
  • A buyer in the same industry will have synergies – these will drive the sale and add to potential
    0.0liquidity of the buyer. While most buyers argue that the synergies should not be reflected in the
    0.0sale price they allow flexibility.
  • The availability of capital. Most external buyers (certainly those derived from proper screening)
    0.0will have available capital.
  • The best price for a business is usually achieved when there is competition amongst buyers.
    0.0When selecting potential buyers in a structured process more than one potential buyer is likely
    0.0to be identified.
  • The potential sale may not remain confidential.


External Buyer Disadvantages

  • The costs of marketing. To generate interest in your business with a view to obtaining the best
    0.0selling price requires skill, experience, and time and it doesn’t come cheap.  In fact, the costs of
    0.0finding a buyer are usually more than the legal costs of executing a sale.
  • Divulging sensitive information before the sale even with an NDA. An external buyer will know
    0.0little of your business.  It follows that most external sales precede an extensive due diligence
    0.0process.  Any buyer will have to sign an NDA but it is uncomfortable providing detailed information
    0.0to a potential competitor.
  • The potential reaction of customers to a change of control. Many commercial contracts now contain
    0.0change of control clauses allowing termination in case of a change of control.  Customer reaction is
    0.0a factor to take into account on an external sale.
  • The contractual burden giving warranties and disclosure.  An external buyer will seek extensive legal
    0.0assurances as to the state of your business.  Great care must be taken when giving these assurances
    .00as any claims are likely to be capped at the total sale price.  Essentially everything will be on the line.

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