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Page written by Michael David. Last reviewed on October 4, 2024. Next review due October 1, 2025.
Suitable for any industry, a management buyout, or MBO, can turn employees into entrepreneurs, monetise an owner’s share of a business, spin a department away from a parent company, or take a business from being publicly-traded to privately owned. In 2013, Dell Technologies used a management buyout to take the computing giant out of public hands. With the flexibility to fulfil almost any change of ownership for every type of company, an MBO is the Swiss army knife of finance tools.
A management buyout, or MBO, involves the purchase of a business by its existing management team, usually with the help of external financing. In most cases, the management team takes full control and ownership of the business and the old owners retire or move on to other ventures.
The most common reasons for an MBO are:
When a business is going through change of ownership, the MBO is an alternative to liquidation, or selling, merging, or transferring the business to a third-party. For owners wishing to sell, the MBO may be preferable to a trade sale for a variety of reasons: It eliminates the time-consuming task of finding a trade buyer. There’s no need to approach competitors and disclose sensitive or proprietary information. They can leave the company in “safe hands”. (Which can be important when the seller has a strong emotional attachment to the business).
For managers wishing to buy, an MBO gives them ownership of a business they already know. This removes the uncertainty of a startup, and the risks associated with the purchase of an unknown entity.
Typically, an MBO will take up to six months to complete. It can be a complex activity, requiring the input of lawyers, analysts, and accountants, as well as the support of funders, lenders, and possibly equity investors.
From start to finish, an MBO works like this:
Financing a management buyout is often the most difficult step in the purchase process. There are multiple ways to fund an MBO and cash, debt, and/or equity investment may all play their part. Swoop’s funding resources can provide the expertise and advice you require to complete your MBO. Register with us to discover which funding routes are best for your transaction.
Pros
Compared to a trade sale, an MBO can offer advantages to both buyer and seller. The most obvious of which is the smooth transition from one owner to the next. Because the buyers in an MBO are already closely associated with the company, their continued presence can be soothing to existing customers, partners, vendors, and employees. A management buyout indicates minimal disruption and a continuation of ‘business as usual’, (even though the new owners will usually have new ideas for running the company).
An MBO protects sensitive and proprietary information. In a trade sale, potential buyers will demand to see the internal workings of the company. Advantageous processes that have been kept secret may be revealed. This can leave them vulnerable to copycat operators.
The management buyout team will usually be familiar with the company’s health. This can reduce the due diligence and speed up the transaction.
Lastly, an MBO offers the seller the opportunity to find the company ‘a good home’. This can be particularly important with a family business where the emotional attachment may be strong.
Cons
In an MBO, the company’s potential for future success is reliant on the expertise of current management. In situations where a company is being sold from distress or administration, funders may question the role of the management team in the company’s performance. If funders determine that the buyout team were pivotal in the business’s decline, that may present a roadblock to financing.
Even if the company is healthy and being sold from a position of strength, the skills and experience of the buyout team can be an issue for funders. Where the outgoing owner has had an outsize influence on the success of the business, funders may determine that the strengths of the remaining management team are insufficient to drive the company forwards.
The transition from a managerial to an entrepreneurial position can be challenging for some buyout teams. This may create stresses that negatively affect the growth of the business.
The buyout team will be required to invest in the sale. Team members without sufficient liquid capital may be forced to use their home, pension pot or other assets as collateral for a loan. If the business fails after MBO, those assets may be forfeited.
An LBO, or leveraged buyout, is much the same as an MBO – the business management team buys all or part of the business from the current owners. However, unlike an MBO, where funds are raised from the buyout team and external funders, in an LBO, the company’s existing assets are sold or pledged as collateral to raise some or all the purchase cash.
This process is similar to the popular lease-back financing model. In a lease-back, a company will sell a hard asset, such as a building, to raise funds. It will then lease the same building back from the new owner. This allows the company to monetise non-performing assets to raise funds for operations, but still have the asset available for business use.
In an LBO, this type of lending is called asset finance. The buyout team leverages the value of assets such as property, plant, or machinery, to borrow money to buy the business from the outgoing owner. The new owners will still be able to use those assets, but they will now make repayments and pay interest until the loans are satisfied. An LBO reduces the asset value of the business as it simultaneously increases the debt burden.
Confused? Our pool of experienced lenders can advise you on the most appropriate form of funding for your transaction. Register with Swoop to find out if an LBO is suitable for you.
No matter if an MBI, an MBO or a BIMBO is used to purchase a business, the outcome is still the same – new management takes over from old. However, there are differences between these purchase models:
Management buy-in (MBI)
In an MBI, a third-party team from outside the company buys the business from the current owners to become the company’s new management. They usually replace the existing management in key roles. This makes an MBI different from a simple trade sale, where a buyer purchases the business, but leaves the existing management team intact. Management buy-in teams are sometimes called ‘turnaround teams’ and they will often compete with other potential purchasers for the business. This may produce a better sale price for the outgoing owners.
Buy-in management buyout (BIMBO)
A BIMBO is a hybrid purchase transaction. It incorporates elements of an MBO and an MBI. In a BIMBO, outside managers join with existing inside managers to buy the company from the outgoing owners. The outside managers buy-in, whilst the inside managers buy-out the old owners. It is a purchasing partnership between the existing management team and a new management team. A BIMBO can reduce the amount of external borrowing required, as the pool of purchasers is increased. It can also bring in new talent that enhances the business proposition to potential funders.
Management buyouts are a popular choice for businesses in the US looking to change their senior management and take full control of the business. There have been some high-profile examples of these buyouts in recent years:
An MBO is a complex transaction and all too often, the buyout team will be too busy pushing the deal through to consider the tax implications of their purchase. It is only later, when they go to cash out from the business that they realise their mistakes.
Potential tax considerations for a management team following an MBO:
Employment taxes
Tangible assets
Fortunately, the IRS has some rules that make the process simpler, potentially reducing or eliminating some of these implications. Register with Swoop to discuss your MBO structure before you finalise the purchase with the seller, or to discuss any tax considerations.
The most difficult part of any MBO is funding the transaction. It is rare for the buyout team to have enough liquid capital to buy the business for cash, which means there is usually a need for external funding. The most popular routes to secure this money are:
Private loan
Members of the buyout team use unsecured and secured personal loans to fund the MBO. For secured lending, team members will provide their homes, pension plans and other non-cash assets as collateral The loans may take the form of equity release mortgages, bank loans, or finance company loans. Good credit references are usually essential and, as with all secured lending, these assets are at risk should the business fail after the MBO.
Business loan
Business loans from bank or finance companies may be obtained to fund the transaction. Depending on the track record and the type of business being purchased, unsecured lending may be possible. However, unsecured lending is generally much smaller than secured lending and, in many cases, the lender will take a lien on the company and all its assets, including its sales ledger, to secure the borrowing. Loan terms are typically 3 to 5 years.
Asset-backed lending
Leveraging against the assets in the company, such as property, stocks, or debtors. If the business owns substantial assets, those assets may be used as collateral for borrowing. This type of arrangement is called a leveraged buy-out, as the company’s assets are leveraged to buy out the old owner. With an LBO, the balance sheet’s liability burden will increase at the same time as its asset base reduces. The business will usually retain full access to the assets during the term of the loan.
Private equity (PE)
A steadily increasing source of finance even at the smaller end of the market. Cash is provided by venture capitalists, hedge funds and private investors in exchange for shares, board seats, dividends, fees, and varying degrees of control. This source of funding can be harder to obtain, but it can offer the chance to scale up as the company grows. Many VC and equity lenders will have an exit strategy that sees them liquidating their position in 1 to 3 years. The management team may need to find replacement funds at that point. They will also repay the lender based on future valuation. If the business has seen growth, this may mean the sum repaid is substantially larger than the sum invested.
A hybrid of debt and equity financing that gives the lender the right to convert to an equity interest in the company in case of default, generally, after venture capital companies and other senior lenders are paid.
Seller loan
Also called vendor loans. The seller helps to fund the transaction by leaving some of their consideration in the company as loan notes to be repaid over time. In effect, their ownership reduces over an extended period. The old owner may retain a degree of control until they are completely paid out.
If a management buyout is not possible, how else can a company change ownership? It depends on who you are – the owner wishing to exit, or the employees wishing to buy.
The owner wishing to exit
The owner of the business has a greater range of options to disburse their interest in the company than the employees. Although an MBO would seem the most likely candidate to secure succession, other options include:
The employees wishing to buy
If an MBO is not feasible, the company employees could still purchase the business via an employee buyout. This form is succession involves all the company employees, not just the management team and they can own the business in various ways, either directly or indirectly.
Should an MBO or an employee buyout not be possible, the management team could also consider a startup. This would be a completely new business, but it would have the benefit of the skills, ideas, contacts, and resources of a proven management team, which may make it easier to acquire startup capital in the form of investment, loans, or grants.
MBO, MBI, BIMBO, LBO, trade sale, spin-off, startup – there are many ways to start, buy, or sell a business. Register with Swoop today for confidential advice on the type of transaction that is best for you.
Written by
Michael David is a financial writer and former investment advisor. Writing for Capital Group, Dimensional Fund Advisors, Franklin Templeton Investments, HSBC, Invesco, PIMCO, Vanguard, global insurance companies, major banks and others, he has educated professionals, business owners and consumers about strategies for investing, insurance, banking and corporate finance for more than 20 years.
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