What Is a Management Buyout?
When a business owner is looking to sell their company, making sure the business remains in good hands is often a priority. It can be hard to trust that the buyer will carry on the company’s legacy and provide for future success. In these cases, a management buyout can ease the owner’s concerns and help ensure a smooth transition from seller to buyer.
In a management buyout, the existing management team purchases the company from the owner or owners. Compared to other potential buyers, the management team knows much more about the company, and the seller is also familiar with the management team. This can make selling to the management team attractive to the business owner, as it is likely the company’s success will continue under the new leadership.
What Is a Management Buyout?
Simply put, a management buyout is when the existing management team “buys out” the owner(s) and acquires the company. If the management team uses debt to help finance the acquisition, the management buyout (or MBO) is called a leveraged management buyout, because it is a leveraged buyout (or LBO) transaction. As an LBO, management buyouts are funded mostly with borrowed capital, and, frequently, seller financing is used for a portion of the total consideration.
Management buyouts can occur when the company owner is ready to retire or the management team wants to take on more responsibility. The management team may want to make more leadership decisions, obtain greater financial benefits, or simply take the company to new heights of growth. The management team may feel they have the expertise necessary to guide the company to greater success, and that the most efficient way to do so is through a management buyout. It also is a way for management to have a larger stake in company success, by moving from “employee” to “owner” and sharing in the profits generated by the business.
The Management Buyout Process
Typically management buyouts are directly negotiated transactions between the business owners and the management team. It is rare to see the management team participating in a competitive situation— with multiple buyers— as most buyers want to work with an existing management team, and not bid against them. For this reason, should an owner want to sell in an auction process, the management team is commonly not allowed to participate as a buyer.
A successful management buyout may take years to culminate from the initial conversations to a closed transaction. First the owners or the team must approach the other party, then both parties must discuss valuation and deal structure. After that, they have to agree on terms, and the management team must secure necessary financing— all while everyone is still running the business. Needless to say, this process can be lengthy. As the management team often does not have the capital necessary to purchase the company, arranging for financing— both equity and debt— is usually a challenge. The management team also may conduct due diligence, but it is far less extensive than if an external buyer were to acquire the company.
Advantages and Disadvantages
As stated earlier, management’s knowledge of the company can offer many benefits. Due to this familiarity, the due diligence process is much quicker. There also may be a greater potential for future success, as management is able to assume ownership and hit the ground running. In contrast, it would take time and money to educate an external buyer on the company— and therefore, take longer to build company success. The transition can benefit employees, as well; as management rises to ownership, advancement opportunities open up. Another benefit is the assumption that the business will be run as before, which is good for maintaining employee and customer trust.
As positive as an MBO can be, conflicts can also arise. The previous owners may struggle to hand the baton to management and transfer control. At the same time, the transition from manager to owner can be challenging for the new owners, especially if they have no past ownership experience. Naturally, owning a business is different from a managerial role and this learning curve can be steep.
When it comes to purchase price, a seller may receive less than if the transaction occurred with a competitive auction. But the seller may prefer this for several reasons: they like the managers and want them to be owners, the sale process is less disruptive than a drawn out auction which includes management meetings, site visits, etc., and selling to the management team helps solidify the legacy and customer continuity versus selling to a competitor.
Management Buyout vs. Management Buyin
The opposite of a management buyout is a management buyin (MBI). In a management buyin, an external management team purchases all or the majority of a company. This is an option when the company is lacking a successor. In these situations, a new management team can provide much-needed guidance to stimulate business growth. Likewise, a succession solution enables the company to continue thriving. A MBI opportunity can be attractive to buyers, as well: the new owners have the opportunity to grow the company and create significant value for themselves.
Financing a Management Buyout
Oftentimes, the management team does not have the funds necessary to acquire the business. As stated earlier, financing the transaction is usually the hardest part of an MBO. From debt financing with banks, to seller financing, to partnering with a private equity firm, there are a variety of financing options.
Debt Financing
One option is borrowing from a bank. Typically with debt financing, the management team is expected to provide most of the capital, with the bank filling the gap. The problem is banks often view an MBO as too risky, and may not be willing to lend the funds. Banks also look for collateral and/or personal guarantees— both of which might be lacking or insufficient.
Seller Note
The previous owner may be willing to issue a seller note, which allows the buyer to repay a portion of the purchase price over an extended period. Thus the financing will come out of the business’s future success, bridging the gap between the full purchase price and what the management team is currently able to finance themselves or with a traditional senior loan.
Mezzanine Debt
Another option is mezzanine financing. Although mezzanine financing comes with higher interest rates, it is a way to obtain capital without the backing of collateral. Because mezzanine debt is more expensive than senior debt, it often complements other methods of primary financing.
Private Equity and Management Buyouts
When a bank is reluctant to lend capital, partnering with a private equity firm to complete the buyout can be a good option. Private equity firms have capital and relationships with debt providers to help finance the transaction. Once the transaction is complete, private equity firms can offer support for business operations.
However, it is important to investigate the private equity firm before initiating a partnership to make sure the firm and the buyer’s goals are aligned. When the firm and the new owners are working together toward a common goal, the company can reach new levels of growth.
F/S Manufacturing and 1719 Partners
F/S Manufacturing is an agricultural equipment supplier specializing in designing, manufacturing, and assembling top-quality liquid material handling equipment. This specialty equipment includes sprayers, mixing tanks, liquid or fertilizer storage tanks, hose reels, tenders, and trailers. Since its founding in 1990, the company has been a trusted resource for the agricultural industry’s needs.
F/S Manufacturing’s senior management had worked at the company for a long time and knew the company very well. When they wanted to become owners, they partnered with 1719 Partners to facilitate the management buyout. 1719 is excited to support the new owners and take the company to even greater success. We believe the company is positioned to expand its product line beyond the current offerings, and we look forward to seeing F/S grow.
Final Thoughts
Management buyouts can be intimidating and complex, but with the right strategy they have a high potential for success. Open communication between the buyer and seller as well as the buyer with any partners is important for a successful MBO. Partnering with an experienced buyer of small businesses can increase the chance of a great outcome. If you are considering a management buyout or have questions about the process, 1719 is happy to help. Contact us to be in touch.
