The pros and cons of management buy-outs
Management buy-outs have disadvantages but are outweighed by benefits and funding options
“You see situations where the key family member is in their late 60s or 70s and wants to exit the business and the children are well educated and not necessarily interested in working in it”
Selling a business to its existing management team can be an attractive option for a number of reasons. The deal can usually be done quickly and privately with minimum disruption to the business while the owner also gets to pass on the business to the people who know it best, thereby helping to secure their legacy.
Of course, there are other issues at play as well. “You see situations where the key family member is in their late 60s or 70s and wants to leave the business and the children are well educated and not necessarily interested in working in it,” notes Paul Keenan, chair of Capnua corporate finance. “Selling to the management can be a logical alternative to passing it on to children.”
A management buy-out (MBO) can also offer more certainty. “Where a business faces headwinds in the form of Brexit and so on, the management may take a longer term view than other buyers,” Keenan adds. “They are not put off by current uncertainties and there is much more certainty of the deal going through.”
Richard Duffy, BDO corporate finance director, agrees. “From a seller’s perspective you get certainty over an exit where there is no apparent successor to take over the reins in a family business situation.”
MBOs are particularly attractive to owners keen to leave a legacy and who feel a close connection with senior management and employees, says Dennis Agnew, corporate partner with Pinsent Masons. “Some owners will also view other exit strategies as overly complex and expensive. Risk is also a consideration – opening up your books for competitors as part of a trade sale or auction can be an uncomfortable process and there is no guarantee of a completion.”
It also avoids the auction process. You don’t get competitors finding out about the process and creating potential risk to the business
Nicholas O’Gorman, Davy corporate finance director, agrees that MBOs tend to carry less risk. “The management team offers the best hope for a quicker transaction and has low execution risk. They know the business better than anyone else and one would think that if they come forward with an offer there shouldn’t be any last minute issues or hitches. It also avoids the auction process. You don’t get competitors finding out about the process and creating potential risk to the business by telling customers and suppliers or even employees about what’s going on.”
“An MBO provides an ability to do a quiet deal in the market without pushing the business around to the trade which can unsettle staff, customers, and suppliers potentially impacting adversely on the businesses value,” Duffy adds.
Confidentiality is important but not the only advantage, says Jan Fitzell, mergers and acquisitions partner with Deloitte. “MBOs are often appropriate when sellers wish to conclude a transaction quickly and confidentially. This can occur for a variety of reasons – the seller may require cash quickly for other parts of its organisation or may be reluctant to engage with other parties for fear of a leak or word escaping to the market that the business is for sale. Management teams, given that they know the business so well, require less diligence to be performed than a third party acquirer and the legal process is typically also expedited through a less rigorous warranty process,” he adds. “Other advantages to the seller include the business staying in ‘friendly’ hands and rewarding management for their past efforts.”
There are disadvantages, of course, and the main one is price. The price which is offered, or can be afforded, by the management team is usually lower than what can be achieved on the open market.
“There is still a gap between the price expectations of sellers and the amount the buyers are able to raise in many cases,”says Owen Travers, AIB corporate finance managing director. “Maybe Brexit and other events will bring about a reality check. The owners may have their own idea about the price, but the management team still has to go to the market to raise funds and the markets will have their own view of the value of the company.” Duffy concurs. “At the moment the biggest hurdle is price expectations and incumbent owners of companies potentially overvaluing their businesses. However, we are optimistic on the outlook for MBOs for the reminder of the year given the level of engagement we have with prospective MBO teams and potential sellers at the moment.”
Keenan believes the price differential doesn’t make much of a difference in reality. “We have handled a number of MBOs in the last year – including Mercury Engineering, the largest MBO in Ireland for the last 10 years, as well as Elvery’s and Ardmac – so we have considerable experience in the space. In a lot of businesses, the management team is critical to success and if you are selling to a trade buyer, you’ll have to give them something anyway. The reduced valuation probably makes no difference in the end.”
Management teams have a lot of power over the value of a business and if the process is not handled professionally it will not end well for them
Timing is another issue. A management team with ambitions to own the business should be careful when it comes to revealing their hand. “It can be very difficult for management teams to have that conversation with owners”, Travers notes. “If it is not carefully managed it can be detrimental to the managers’ careers. It’s a delicate conversation to have. Management teams have a lot of power over the value of a business and if the process is not handled professionally it will not end well for them.”
On a more positive note, there is ample funding in the market to support such deals. “There is so much money around at the moment there won’t be enough MBOs to take it up,” says Michael Hussey, Davy associate director. “MBOs have become a feature of Irish corporate life and are here to stay. There are very few good companies in Ireland that don’t sell abroad. By their nature they are pretty ambitious, and this means they can attract capital. Valuations can be attractive for all in these circumstances.”
An MBO is typically funded by a lending bank and often will involve an equity injection from a third party private equity fund, according to Jan Fitzell. “Sometimes the seller will provide a portion of the finance via a vendor loan note or some such similar instrument”, he adds. “The management team involved in the deal will usually contribute to the funding package and while the overall quantum is a modest portion of overall value, it helps to ensure that they have ‘skin in the game’ and are aligned with lenders and third party equity providers from a risk perspective.
“There are a range of private equity firms who will support MBOs, all with a different approach, preference for particular sectors or operating culture,” he continues. “Matching the private equity fund with the dynamics of the business and the MBO team is a critical factor in successfully funding the deal. In addition, designing the appropriate funding structure at the outset and ensuring that the balance between achieving a valuation which is acceptable to the sellers and a funding structure which maximises the position of the MBO team is an important aspect which merits careful consideration.”