Nick Johnson, Corporate Finance partner at Ryecroft Glenton, and veteran of over 150 transactions over 25 years in the Corporate Finance arena, helps demystify the complex world of MBOs.
- What is a management buyout (MBO)?
An MBO is a transaction where the management team of a business acquire either all or most of the shares of the business, with funding from a variety of sources.
It can be one of the most complex and challenging types of transaction as it involves both the acquisition/sale of a business and the raising of funding to support the acquisition. As such there are a lot of different parties, with different aims and objectives, each with their own advisers – not always a recipe for plain sailing.
The opportunity for an MBO will typically arise in two scenarios – either when a larger corporate is looking to divest of a non-core subsidiary/division or when the shareholders of a private company are looking to realise value and would prefer to sell to management as opposed to a trade buyer.
MBOs first became a feature of the corporate landscape in the 1980s originating in the US, spreading first to the UK and then throughout the rest of Europe. The venture capital and private equity industry has played a crucial role in the development of buyouts in Europe, although there are many ways in which an MBO can be structured and funded for example:
- A Vendor Initiated Management Buy Out (“VIMBO”)
- Private Equity
- Debt Fund
The term MBO can apply to transactions covering a wide range of size and complexity. However, when looking at some of the much larger deals supported by private equity giants like KKR the more accurate term is Leveraged Buyout (LBO) as opposed to MBO. The important feature for a transaction to qualify as an MBO is for management to be acting as the buyer principal.
- Types of MBO
A VIMBO is a vendor controlled/facilitated sale of a business to the management team, with the shareholders assisting in the funding/structuring of a successful transaction.
A VIMBO is typically funded by a combination of various types of debt (term loan, asset-based lending etc) management contribution and vendor contribution. The vendor funding can take many forms, for example: loan notes, minority equity stakes, and earn outs. Ordinarily management will be required to provide a relatively small (in relation to the transaction) but personally meaningful investment.
- Private Equity
A Private Equity (“PE”) backed MBO involves the management team and a PE investor together acquiring either all or most of a company’s equity. A PE backed MBO may be viewed by the vendor as a means of increasing value although this is not necessarily always going to follow. PE involvement can mean more than simply a source of funds, as PE investors use their significant experience and network to help businesses and management to grow and fulfil their potential.
A PE backed MBO is typically funded by a combination of PE debt, PE equity, bank debt, asset backed lending, management contribution and potentially some vendor contribution. A vendor may have some deferred payments or a minority equity stake. Ordinarily management will be required to make a relatively small, albeit personally meaningful, investment.
- Debt Fund
A Debt Fund backed MBO involves the management team raising long term debt from the specialist debt market to acquire either all or most of a company’s equity. A Debt Fund may be an appropriate solution depending on the objectives of the vendors and the management team.
A Debt Fund backed MBO is typically funded by a combination of loans from the Debt Fund, management contribution and potentially some vendor contribution. A vendor may have some deferred payments or a minority equity stake. Management will usually be required to make a small but meaningful contribution to the equity. Debt Funds may require a redemption premium or equity warrant providing value upside in the event of an exit.
- Key Success Factors
A successful MBO needs a combination of factors in place to ensure the best chance of a positive outcome:
- First and foremost an owner that is motivated to sell and recognises the benefits of selling to the management team;
- A high-quality management team with an appropriate spread of skills and talents;
- A viable and high-quality business that can service the funding structure required to support the transaction. Many MBO structures involve relatively high levels of leverage and therefore it is very important that there is plenty of cash headroom in any structure; and
- A financial deal that will work for all the stakeholders – the business, the management, the owners and the funders.
Despite the complexity and the different ingredients required to serve up a successful MBO many studies have shown that they are amongst some of the most successful businesses in the UK. One can speculate on the reasons for this – management being freed from constraints, management focused on value creation and the impact of external funders can all play a part.
In my career the MBOs have been some of the most rewarding experiences – working with management teams to buy a business, and then working with them as they grow the business to the point where it is time to pass the baton to another owner for the next stage of growth, whether it be a sale to trade or a secondary buyout (SMBO) to the upcoming management team.
MBOs are certainly an important and established feature of the M&A landscape, Ryecroft Glenton has advised on many MBOs in the last 12 months including the MBO of GadCap Technical Solutions Limited from its overseas multinational parent, the MBO of Alexander Technologies Europe Limited from US based Woodside Capital Partners, and the MBO of Impact Recruitment from its founders – with many more in the pipeline for 2020!