A Guide to Management Buyouts (Definition and Process)
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A change in management is common practice in corporate businesses, whether through acquisitions, restructuring, or business sales. Sometimes, small- and medium-sized enterprises experience a buyout, where managers who already have a stake in the business purchase the entire organization. Understanding the implications of this type of buyout can help you plan ahead and manoeuvre your career path during a corporate restructuring.
In this article, we define what management buyouts are, explain how the process works, detail the advantages and challenges, and explain how you can advance your career during a buyout.
What are management buyouts?
Management buyouts (MBO) are a business transaction where the management team of a company purchases the operations, procedures, intellectual property, and physical assets of the organization. A common reason for an MBO is to enable the company to increase its profits by becoming private and reducing employees.
Each specialized professional in the management team leads a section of the company, such as human resources, finance, operations, and sales. Depending on the size of the business, members of the management team employ mid-level positions to conduct daily operations and lead the team of employees in their department.
An MBO typically requires financing from private equity, personal savings, or seller financing. The result is that the internal management team obtains full control over the business.
How the buyout process works
The MBO process follows procedures defined by finance regulations, corporate standards, and legal protocols. Unlike a buy-in process where an external management company replaces the existing management team, an MBO usually happens for one of two reasons, divesting interests or retirement.
When large corporations change direction, they often have a stake in companies that no longer represent their values, goals, or brand. They can divest the business through an MBO. Another common reason for an MBO is the retirement of the company's owner. This usually occurs in small enterprises and typically doesn't have an impact on employees or procedures.
In these situations, there's an established plan of succession, but the transition can take longer. Whatever the scenario, an MBO typically complies with the following steps for restructuring:
During the analysis phase, the managers conduct market research on prospective buyers and competitors in the industry. There's also a thorough investigation into the supply chain, financial documents, and customer data. This stage is usually less time-consuming in an MBO because those purchasing the company already work in a management capacity, so the information is readily accessible. As this is an investment, it's important for the management team to perform a cost–benefit analysis on the MBO.
Equipped with the analysis data, the managers approach the seller with a purchase offer. The business owner usually conducts an independent evaluation to determine the value of the company. The buyer and seller communicate, either personally or through a legal team, and settle on the terms of sale. These include the price of the purchase and, usually, a deadline for the funding.
During the funding phase, the managers purchasing the company obtain the requisite funds. Using the information from the business analysis, the managers can create forecasted financial models that show projected return rates for potential investors. There are various ways to approach financing, including personal savings, traditional bank loans and lines of credit, or alternative loans.
A common method is to secure a loan provided by the company's owner, known as seller financing. Many companies pursue private equity investment, where an investor offers funding in exchange for a portion of the company. In the mezzanine finance approach, the lender offers a loan with interest and claims a portion of the company if the buyer doesn't repay the loan.
Instalment funding involves acquiring a loan from the seller and repaying the amount in instalments with interest. In corporate scenarios, employee stock options can provide funds while reducing compensation costs because they replace cash benefits with stock value.
After the purchasers obtain funding, the next step is planning the transition of leadership. Depending on the goals of restructuring, buyouts can involve either hiring new employees or layoffs. Most procedures remain consistent because an MBO is internal, but it requires careful communication with employees, organization of the tax and corporate structure, and the design of a succession plan for the business.
Transaction and transfer
Business sales are subject to federal and provincial legislation, and an MBO transfer involves a legal transfer of ownership to the new company authority. Legal professionals facilitate the actual conveyance procedure to help ensure the timely transmission of documents, including registration, insurance, and licensing. The transfer process time can vary depending on the complexity of the MBO, but it typically takes between six months and a year.
Once the MBO is complete, the purchaser begins the repayment process with the businesses or individuals that financed it. The purchaser follows the repayment agreement according to the established terms. Even if the purchase funds come from a personal source, there are procedures that detail when it's appropriate to withdraw business funds. The exact terms of repayment can vary based on the type of financing.
Benefits and challenges of management buyouts
A buyout of this type is popular among hedge fund professionals and large financial entities. A company can streamline its operations and increase profits without the public being aware. Once the MBO takes effect and the business is growing under new supervision, the company can return to the public market with a higher value. While an MBO is an opportunity, there are both benefits and challenges to this type of purchase. Here's an explanation of both the benefits and challenges of an MBO:
Benefits of an MBO
There are many benefits to an MBO, including:
Speed of transition: Because the purchasers already work with the company, they already understand it from a high-level perspective. This can accelerate the transactional process because they spend less time dealing with assessments and analyses.
Business insight: With an MBO, the buyer has proprietary information on the organization and can use that insight to increase business success. It also keeps any confidential details securely in-house during the management transition.
Employee retention: Unlike an outside company purchasing the business, there's a reduced risk of layoffs because the processes are likely to remain consistent. Although the management has control over decisions under the new structure, it's less likely to make significant changes because it probably purchased the company due to its effectiveness.
Improved value: Management purchasing a company allows the business to grow in the private sector and increase its market share and value. The valuation may be significantly higher when it makes an initial public offering.
Challenges of an MBO
MBOs can also involve challenges, such as:
Impact on company culture: The transition of a manager to the role of owner and lead decision-maker can risk changes to the company culture. It may cause a change in mindset that has an impact on interactions with employees.
Additional responsibility: When managers become owners, they have full responsibility for the success of the business. This additional authority, and the obligations that come with it, can lead to unexpected behavioural changes in the new owner.
Financial risk for owners and buyers: The seller of the company incurs a higher level of risk with an MBO when compared with management buy-in, because internal managers have insight that can lead them to undervalue the company. Trusting the reasons why a business wants to make a sale can be a risk for those purchasing the company.
Benefits of management restructuring in career development
A change in business structure can have benefits for both the purchaser and the employees. As a manager or other leadership professional, an MBO offers many opportunities to advance your career, such as:
Promotions and growth
As an employee of a company undergoing an MBO, you know the buyer is likely to be busy with activities related to the sale. You can help your career prospects by being useful during the management transition, offering valuable assistance, and demonstrating your leadership abilities. In this way, you may become an obvious candidate if the new owner decides to hire a manager to run daily operations during the restructure.
Increased company value
An MBO typically adds to the company's overall value, and if you're a long-term member of the team, you can use this to help your career. Growing companies have opportunities for professional development, so you can discuss your aspirations with the new owner and learn about the options available. If the restructuring results in additional work for you to achieve that increased value, you can consult with the owner to negotiate compensation.
An MBO unifies the decision-making process by providing the management team with the authority to choose the business direction. Management making the final decisions can increase efficiency and streamline communication. During restructuring, there's typically a desire for business growth and change, so you can use an MBO to pitch your ideas for improvement.
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