MBO stands for Management Buy-Out and is a form of acquisition where a company’s existing managers acquire a large part or all of the company from either the parent company or from the private owners.
An MBO is one alternative for an owner-entrepreneur to exit his or her business. The management team buying the business can range from an experienced arm’s length team to family members who are active in the business.
The terms MBO and LBO (leveraged buyout) are sometimes used interchangeably as third party debt such as bank term loans and mezzanine financing (unsecured, subordinated debt) is often used to fund an MBO.
The advantages of an MBO include:
- Low Transition Risk
The buying managers know how to run the business. Management continuity is usually a big issue in the sale of a business and keeping management in place adds tremendously to the finance-ability of the transaction.
- Minimum Disruption
Putting a business up for sale creates a period of uncertainty that direct competitors can capitalize on. While this threat is often overestimated, this rational will influence certain entrepreneurs to choose this path.
The drawbacks of an MBO include:
- Sub-optimal Price
An auction process among strategic buyers that have the most to gain from the acquisition will most often realize the highest price. One cannot predict what price a strategic buyer might pay. See: “What Will a Strategic Buyer Pay?”.
In some cases management and the seller negotiate a fair and do-able price and in other cases an independent valuation is performed but in either case it is not likely to be equal to what a strategic buyer might pay.
- Sub-optimal Structure
Unless there has been a plan in place for years, buying managers typically don’t have sufficient cash on hand to buy the business. As a result, in most MBOs you will see vendor notes (VTB) where the seller finances part of the purchase price for the buyer.
One big exception…
However, there is one big exception to the drawbacks and that is if the management team can attract the attention of a financial buyer. I noted in “What Will a Financial Buyer Pay?”, that a financial buyer will pay like a strategic buyer when it is considering portfolio add-ons. A strong management team that aligns itself with private equity that has other investments in the space can be a very strong buyer. Now the question becomes: does the management team want to partner with an institutional investor and pay that much?
Decide before proceeding with an auction process
The decision to sell to management is one that should be addressed early and definitively. Management should not be included in the auction process. This creates a conflict of interest where management is incented to act in its self interest. There are also expectations to manage. If management is keen to buy the business but cannot come to terms with the seller, or cannot secure the financing, then they may be seriously demotivated and not work in the best interest of the auction process.
An MBO can be a good option if the buying management team is strong and is interested in partnering with an institutional backer that can bring cash to the transaction. If the MBO is pursued simply because other options are not of interest then the seller must be satisfied with potentially accepting a lower value proposition.
Recommended Further Reading
For more on how long an acquisition takes, see: How Long Does it Take to Sell a Business?
For a more in depth review of CIMs, NDAs and PSAs, see: Terminology and Documentation