How to execute a successful management buy-out

Fans of the eponymous TV series might be forgiven for thinking succession is all about family. It’s not. For many business owners looking to exit, finding a member of the next generation willing, or able, to take over may not be an option. The solution may be in the office next door.

“It depends what the motivating factor for the exit is. If it is about the founder being at that stage in life, and facing a succession issue where there is no one in the family coming through, a management buy-out (MBO) can make sense,” says John Bowe, partner in Mazars Corporate Finance.

Selling to staff brings a number of advantages. Once you can agree a valuation it can take less time than a trade sale. If the management team can fund the MBO, there is less due diligence involved. It also avoids news of a trade sale seeping out, which can be a blow to staff morale and raise both customer and supplier concerns.

On the flip side, cautions Bowe, if value and price is the owner’s main motivation, the management team might not be able to raise the highest price. Speed is not guaranteed either. “If the management team is backed by a private equity house it will undertake its own due diligence anyway,” he says.

There are other risks, including the nightmare prospect of a failed MBO, after which a disenchanted top team jumps ship or, worse still, stays on.

“For the MBO team coming in it is generally their first transaction. If the seller is the business founder, very often it is his or her first sale too, so everybody is really nervous,” says Katharine Byrne, head of the BDO Corporate Finance Team.

The good news is that because the stakes are so high if it goes wrong, “once they go down the MBO route both sides tend to be very much wedded to the process”, says Byrne.

The best way to ensure good relations is to be open and transparent from the outset. Then work towards a “win/win”’ for both sides.

“The MBO team will want to buy the business at the best possible price so that they can make some money when it comes time for them to exit in a few years’ time. If it is a corporate seller, what they might want most is a nice smooth process. If it is a founder that is selling, there will be legacy issues involved. They will typically want the business to continue to grow, and so will be a lot more supportive of the MBO,” says Byrne.

Top team

Some 95 per cent of Irish businesses are small and medium sized enterprises, many of which are owned by their founder. Grooming a top team capable, and willing, to step into the owner’s shoes takes many years, a good recruiting and personnel development policy and a willingness to delegate, something which can be difficult for founders.

Ensuring the business is not too closely attached to the owner in the mind of its customers is important too.

“The prep time for the MBO team can take longer, but the transaction can be quicker,” says Byrne.

The fact that the management team knows the business’s weaknesses will also give them some leverage in negotiations, however – they know its weaknesses – so the best strategy for the seller is to address such issues head on.

Just make sure the management team has its funding in place before fully engaging with it. “It seems unfair, but it suits the management team too, because it gives them time to get their funding organised,” says Byrne.

Historically MBO teams relied on debt from banks or specialist lenders to finance the transaction. The global financial crisis provided a painful lesson on the risks inherent in highly leveraging a growing business, “if something happens”, says Byrne.

It is, she says, important to capitalise the deal correctly by assessing what level of appropriate and sustainable debt the business can afford.

Next establish what the funding gap is and how best to fill it, whether via friends and family, the Employment Incentive Investment Scheme (successor to the old Business Expansion Scheme) or via another joint venture partner.

Legal side

The use of private equity to fund MBOs has become much more popular in recent years, says Eanna Mellett, partner in the corporate department of DLA Piper. The world’s second largest law firm opened an office in Ireland in 2019.

Selling to the management team means less time – and money – spent on the legal side of the deal, such as negotiating warrantees.

While with any sale the business owner is advised to first tidy up loose ends, such as outstanding legal proceedings, with an MBO that is often less urgent “because in many cases it would be down to the management team to sort them anyway”, says Mellett.

Moreover, “they already know what is involved, so are less likely to get spooked by them than a third-party buyer”, says his colleague and fellow partner Matthew Cole.

However, both confirm if your MBO team is backed by private equity the funder will want to satisfy itself on all such matters before giving the green light.

There are two parts to a private equity-backed MBO – the negotiations with the seller, and the equity negotiations between the team and the funder. In this scenario the MBO team will typically be looking to make its money on its own exit three to five years later.

The proliferation of private equity houses operating here since the financial crash is changing the way MBOs are done, and mostly for the better. Private equity is willing to accept more risk than traditional trade buyers or debt funders, says Mellett.

For the MBO team it can also mean its liability is capped. If things go pear-shaped in the business, such caps may leave the MBO team members on the hook for “a couple of years’ salary”, but they don’t run the risk of personal guarantees. “Private equity is much more business savvy,” says Mellett.