Key considerations when choosing a management buy-in or buyout

Key considerations when choosing a management buy-in or buyout

When succession planning, it may seem close to an ideal solution as you can get when you want to exit your company to allow your management team to buy the company from you.

Management buyouts have their advantages such as familiarity with the business, consistency of management, minimised risk and ease/speed of a deal. However, a management buy-in may offer advantages to some businesses where a strong internal team isn't in place.

In this blog we look at the difference between a management buyout and buy-in, the process, key considerations for a successful MBO and the pros and cons of management buyouts and buy-ins.

What is the difference between a management buy-in and buyout?

A management buyout (MBO) is when your company is purchased by its existing management team. By contrast, a management buy-in (MBI) is when you sell your company to an incoming team.  The dynamic and pros and cons of each type of deal are different. 

A management buyout team will have extensive experience of the company working alongside you before you exit the business. A management buy-in team will often have sector experience but little or no experience of your specific company.

Understanding management buy-ins

A management buy-in, or MBI, is when outside people buy or take a controlling stake in a company they don't already work for and become the company's new management. As well as investing their own money in the company, they will usually obtain financial backing from external sources such as banks, private equity or other lenders. If a buy-in is successful, the existing management team is often replaced with new managers and board of directors.

The risks are different with an MBI as the MBI team will not have the same detailed knowledge of the company but may well have wider sector experience and could therefore identify and maximise the potential of the business due to synergies, experience and sector knowledge.

Advantages of a management buy-in

• A wider choice of buyers means there may be potential for higher value to be achieved (a possible MBO may deter other potential buyers).

• There may be greater future growth prospects as the new management can be more knowledgeable, connected and experienced.

• The new owners may inject new energy and ideas into the business, and this may be good for employees and growth.

• The change may be desirable if the company doesn't have a strong management team.

• It may allow the owner to exit immediately and achieve proceeds of sale immediately.

   

Disadvantages of a management buy-in

• Given that the incoming team will know little about the business day to day, they are likely to do a more thorough due diligence process.

• They may also demand more assurances in regard to warranty and indemnity protection.

• The current team and employees may well struggle to accept a new management team and new ownership team and treat them with suspicion and scepticism, you may have to manage the hand over and transition more carefully if you remain in the business for any length of time.

• Through the due diligence process, the preferred buyer will want to thoroughly examine the company’s records and management information. If the buyer is a competitor, the process will allow them to access confidential and sensitive information is often a concern for the owner that needs to be carefully managed.

• The current owner may not be able to retain a share in the company or wind down during a transition period, they may have to leave on deal completion.

Understanding management buyouts

For an exiting owner, an MBO will offer an attractive succession plan, due to all the advantages below but one of the key advantages will be continuity of leadership team, no marketing process to sell and no requirement to disclose confidential information to outside parties.

An MBO can be an easier and more attractive option for businesses that have a track record of profitability and a strong, motivated management team with a clear vision of the future direction for the company.

Advantages of a management buyout

An MBO can be an attractive succession plan for the exiting owner for the following reasons:

• The purchasing management team can ensure continuity of management.

• Management information won’t be disclosed to external parties and can remain confidential.

• It will minimise the time and energy that would be needed to market your company to third party buyers, with a MBO your buyers are already in place.

• Often the negotiations on the value of the business can be easier.

• The sale process can often be faster and smoother for the parties involved.

• You may be able to have more control and retain a minority stake in the company.

• The likelihood of a successful completion is far higher than in trade sales.

• Potential for reduced risk than selling to an external party.

• Smooth transition as the main management don't dramatically change and employees may accept them more readily as the new owners.

• Warranties and indemnities given by the business owner in the Share Purchase Agreement will be much simpler if the company is sold to the management team.

• It can be a way for you to reward your key management who have helped you to grow the business and a reward for their loyalty.

• An MBO can be a good option for businesses that are often too small to attract a trade buyer.

Disadvantages of a management buyout

There can be some pitfalls and disadvantages of a management buyout as follows:

• The leadership team currently working in the company are often skilled and experienced in their own individual roles, but often have limited exposure to other parts of the company or aspects of 'running' the wider company.

• The company's management are often busy in their day jobs and so may lack time during the deal process, this means they will need to employ and depend upon professional advice to take as much strain as possible out of the transaction process as possible.

• The current team may not have the financial resources to buy the company outright and may need to negotiate terms such as deferred consideration, meaning you won't get all the proceeds from sale immediately.

• The business valuation may be lower than could be achieved through a trade sale as management teams may not pay for the synergies available to an external buyer.

• Because of the current relationship they have with you as the owner, this may make conversations about the deal, such as price etc. more difficult.

• The process may create conflict. If the deal fails to complete, future relationships may be challenged.

• In many cases the current management teams are not able to raise enough capital to fund an MBO themselves. This could be due to lack of personal wealth and/or experience needed to raise high enough levels of personal funding. They will have to seek external finance and they need to be a strong proposition to secure funding externally.

• If you remain involved, it may be difficult to find the right balance between allowing the new owners take the reins and you letting go.

You may feel because you know the individuals involved, it’s easy to negotiate the deal yourself, but getting lawyers and accountants involved can avoid some of the pitfalls or disagreements that may crop up during the deal process.

If you need business advisory or help with succession planning, contact us today.

Funding an MBO

Ensuring the company's management team has the finance available for the deal is a key consideration. Financing a buyout through management equity is rare. External funding will often be needed via external lenders or a private equity firm.

Deferred consideration is involved in many MBOs and is effectively the vendor acting as a funder. Where consideration is deferred, the buyer obtains the shares or business at completion but pays part of the purchase price at a later date or dates. The deferred consideration may be a fixed amount, or it may be linked to the future performance of the business – this is often referred to as an ‘earn out’.

Third-party lenders may require an element of deferred payment to ensure the vendor is also committed to the transition. High street banks, private equity firms and alternative lenders have been funding many MBOs in recent years.

A leveraged management buyout is much the same as an MBO – the current team buys all or part of the business from the current owners. However, in an LBO, the company’s existing assets are sold or pledged as collateral to raise some or all the purchase funds. 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 management buyout process

A typical MBO process may look like this:

1. Assessing feasibility and viability including initial funding views.

2. Appointment of professional advisors.

3. Assessing tax consequences and tax planning.

4. Negotiate and agree a deal.

5. Draft and sign heads of agreement.

6. Prepare a business plan and projections for funding.

7. Approach funders, compare funding offers, negotiate and select funders.

8. Undertake due diligence.

9. Legal process.

10. Covenants.

11. Deal completion.

How to choose which strategy will best fit your business succession plans

Before considering a management buyout vs a management buy-in, you should ask yourself these questions:

1. Do your management team have the right mix of skills to take the company forward?

2. Have you researched the feasibility of the transaction?

3. Are your senior management team already heavily involved in the day-to-day management of the company?

4. Can the team manage not just operations but finance as well?

5. Can they manage difficult situations where sales may fall, timings may be affected and cashflow becomes tight?

6. Do they have the vision and strategic skills to take the business forward?

Succession planning with Haines Watts, contact us today

Having a succession plan in place well ahead of the time you want to exit your business is crucial. You should revisit your succession plan at least every year as teams and the business changes. Keeping your exit strategy under regular review will put you in the very best position to exit your business and enjoy a long and happy retirement in the knowledge that your company is in safe hands.

Haines Watts works with many clients to create and revise their succession and exit plans. If you are planning a management buy-in or management buy-out, we can give you all the advice you need. We can advise on valuation, raising finance and negotiations.

Contact us today at our offices in Wirral, Chester and Liverpool to discuss succession planning and your exit options.

Conclusion

For current owners, a management buy-out can often be an ideal solution. You may feel that selling to your senior management team is the best solution because you know and trust them, they know the company and can continue your legacy. But an MBO can have its own pitfalls. How do you know that a management buy-out is right for you and the future of your company or is feasible?

When contemplating whether to consider a management buyout or buy-in, forward planning is vital. In an ideal world, the current management team will be well-established and have the correct combination of skills and experience to encourage the support of a funder, you may have to manage the handover and transition more carefully if you remain in the business for any length of time.