Reaping the rewards of an MBO

In association with

For many managers, a management buyout is their first venture as an entrepreneur. It takes courage to leave the comfort and security of a management position to face the challenges of ownership.

By Pauline Rigby, head of corporate and restructuring at Forbes.

However, despite this most managers find the personal satisfaction of controlling their own destiny one of the biggest rewards of an MBO.

Buying a company through an MBO can be a shortcut to financial success. The risk is lower, the financing is easier to obtain and the waiting period for a return on investment is shorter than starting the business from scratch.

It is often done through a newly incorporated holding company that has been set up by the management.

One of the major issues concerning management teams is how they are going to afford to acquire an established business.

It is important to note the MBO team are only usually required to input a relatively small portion of the overall consideration to show their commitment to the deal.

The remaining consideration can comprise:

  • Bank debt: This is likely to form the bulk of the finance and will usually be secured over the assets of the newco and the company itself. This is normally one of the cheapest forms of financing but will require repaying prior to any other financial provider and will have strict terms attached. Depending on the sums lent the bank will almost certainly require individual members of the MBO team to provide personal guarantees and security over their personal assets.
  • Deferred Consideration: Effectively where the exiting shareholders allow a proportion of the consideration to be paid to them in instalments over time.
  • Venture Capital (VC): A VC will assist companies by injecting cash in return for an equity stake. The VC usually has a mid-term plan of typically three to five years where they aim to increase the value of their stake and then exit through a number of routes. They will usually appoint a member of their team to the board of directors but they do not take any direct part in the day to day running.
Whichever funding combination is used, it will be important for the MBO team to prepare a business plan as it will be this that attracts the investors in the first instance.

In essence the process of an MBO is the same as with the sale of any business. Typically though you would expect the due diligence and warranties to be a lot lighter as the buyers will know the business already. However, this will depend on whether any of the funders require a detailed due diligence.

The management team should consider having a shareholders agreement. This is probably one of the most critical documents in an MBO and one of the most difficult to draft. A well drafted shareholders agreement has to address all those difficult ‘what if’ questions such as what happens is someone gets sick, gets fired or dies. How a shareholder exits the business, and how and at what value do they sell their shares, needs to be set out in the agreement.