By Kevin Paget, Coporate Finance Director – Menzies LLP.
For business owners looking to make an exit, it makes sense to consider all the options – from pursuing a trade sale to a management buyout (MBO). Even for those that may not have considered it previously, the latter could come out on top – but is the management team ready to step up?
The combination of low interest rates and pent-up demand for funding opportunities, means there is more money available to the corporate finance market than there has probably ever been. For business owners planning an exit this is good news, as the availability of cash-ready funders means more competition to support management buyout opportunities.
While a trade sale is the most obvious course of action for many stakeholders seeking to realise value on route to retirement, a management buyout could be a viable alternative to consider and potentially a great way to reward loyal staff that have helped to grow the business over the years.
Before deciding to pursue a management buyout, business owners should ensure they understand the potential differences between this course of action and a trade sale, especially with regards to valuation and deal structure. A management buyout will generally value the business at a fair and reasonable market valuation that will typically match the price paid by most third-party trade buyers. However, above market valuations can be achieved when there’s a strategic fit. This could be where the customer base, products, intellectual property, or know-how specifically match the buyers’ acquisition criteria. A trade sale to a buyer with a good strategic fit may therefore realise a higher price than a management buyout, but finding themmay not be easy.
Understanding how a trade sale transaction is typically structured and comparing this to the structure of a management buyout is also an important part of the decision-making process. For the business owner, this means knowing how much cash they would likely receive on completion of the transaction and how much they would receive over time on a deferred basis, in both scenarios.
Seeking advice at an early stage can help business owners understand the valuation range and likely deal structures of a typical trade sale, or a sale to the management team. This understanding will go some way to determining whether a management buyout is a feasible option or not.
A business owner may not want to stop working completely and, in this regard, a management buyout could be a more attractive option. This is because the transaction could allow them to reduce their day-to-day involvement, gradually, over a period of time.
When considering a management buyout, forward planning is crucial. Ideally, the existing management team will be well-established and have the right mix of skills and experience to attract the support of a funder. For private equity firms in particular, funding decisions are often directly linked to the quality of the management team. Consideration should be given to any skill gaps within the current management team and how these will be addressed. Making sure the business has a good in-house, or outsourced, finance function, with robust financial management reporting and processes in place, is also vital when planning any corporate transaction.
Whether it’s a trade sale of management buyout, business owners will need to consider how integral they are to the day-to-day running of the business. The more involved they are, the more difficult it would be to exit the business cleanly on completion of the transaction. For a management buyout, a period of transition, whereby the business owner stays involved, often helps to de-risk funders’ concerns and often makes the fundraising easier. In addition, a period of transition may suit a business owner as they may not want to stop working completely. By staying involved, the business owner can help to ensure the business performs well after the transaction has completed. This could be important if there is some deferred consideration at stake.
Timing is also a key consideration when planning a management buyout. It is important to understand what future trading might look like and a stable, or preferably growing business is likely to attract greater appetite from funders. Key upcoming events that could have a material effect on profitability, either positively or negatively, should also be taken into account as these could affect the valuation and level of funding raised to support the management buyout. For example, if a key customer contract is up for renewal, it may be worth waiting until it has been secured before funding is sought, as this will help to de-risk the proposition from the funders’ perspective.
Some other aspects to consider that make a management buyout more attractive than a trade sale are the due diligence and legal processes. With due diligence, the preferred buyer will want to thoroughly go through the company’s records, before the transaction is legally completed. Where the buyer is a key competitor, giving access to confidential and sensitive information is often an issue for the business owner that needs to be carefully managed. With a sale to the management team the concerns are far less as it is likely that the management team already know the key sensitive information. On the legal front, the warranties and indemnities given by the business owner in the Share Purchase Agreement will be much lighter if the business is sold to the management team, than to a third party, making the transaction easier to navigate during the legal process.
For the business owner, one of the most advantageous things that a management buyout offers is a high degree of control. Once the feasibility of the management buyout has been assessed, valuation agreed and deal structure outlined, it’s very rare that the transaction doesn’t complete. This is not always the case with a trade sale to a third party where there are considerably higher failure rates.
Management buyouts can provide business owners with a very attractive alternative to a trade sale and a chance to realise a fair and reasonable value for the business while rewarding loyal staff for the contribution they have made over the years. With the right advice and guidance from the outset, this option could suit many exiting business owners in the year ahead.
