Advantages and disadvantages of a management buyout
Updated: 6th February 2019
Management buyouts occur when a team of managers and executives work together to buy a business, or part of a business, which they work for.
The situation first arose around 30 years ago and has increased in popularity since. It’s a simple way for existing owners to find willing and knowledgeable buyers, and gives employees the chance to step up and progress their careers.
MBOs can occur in any industry with any size of business. They can be used to break a particular department away from the core business, to allow owners to dispose of their interest, or even to save a business from administration.
But just as an MBO can be the perfect solution in one situation, there are also many pitfalls which would make it unsuitable for another.
Why MBOs are attractive
Selling a business can be a lengthy process, from finding a buyer, through due diligence and onto the transitional period. Selling to existing employees can be much quicker. They’re already involved, already know the ins and outs. As well as a faster and easier sale, the seller also gets peace of mind that their business is being passed onto a group they know and trust.
For the buyers, it’s usually the easiest, quickest and least risky way to step up into an ownership role. This allows individuals to fulfill their ambitions of calling the shots, of taking home a larger slice of the profits. The alternative, to start a business from scratch, contains many more unknowns and can take longer to see positive returns.
In some cases, an MBO will take a company from publicly traded to private. This in itself frees the business from a variety of legislation, paperwork requirements and more. The business can become more streamlined merely by removing these burdens.
The drawbacks of MBOs
MBOs are far from straightforward. In the first instance, it is rare to find a group of managers with enough financial power to be able to buy a business. Additional finance from a bank or private equity house is almost always required.
This changes the dynamics, introducing extra debt or spreading equity thinner. Repayments and dividends eat into profits and squeeze the margins. Many outside investors will also want some form of control over the business. While this may simply be an non-executive director, the MBO team will soon find they’re still answerable to somebody after all.
In addition, investors often want to ensure that the MBO team is committed to the cause by demanding that each individual delves deep into their own pockets to contribute to the purchase.
Already, the risk is dialed up. But a common thread with many MBO teams is that it is a first taste of ownership. Experience at management level does not always translate into the ability to own a business. An MBO team will need to ensure it has the right mix of skills to lead a business, from HR to finance to operations and beyond. One of the team will also need to take an overarching managing director’s role. Agreeing on who this should be, without resentment from other parties, is not always a simple task.
Some employees have also been caught breaking insider trading laws by purposefully allowing the business to underperform, thereby decreasing the sale price in the period before the negotiations.
Take a closer look at the inner workings of an MBO and you’ll see they’re far more complex and laden with much more risk than they may seem at first.
Despite this, studies have shown that these businesses regularly outperform their non-MBO equivalents. There are a great many success stories and it is, after all, an accessible route from wage-earner to company owner.
If you’re considering an MBO, whatever stage you’re at, we are happy to talk you through the process and the viability of your own situation.
Martin has nearly 20 years’ corporate finance experience specialising in advising owner managed businesses. Martin has considerable experience advising on business sales as well as management buy-outs and acquisitions across a wide range of sectors and deal sizes.