For business owners looking to make an exit, it is important to consider all routes available – from pursuing a trade sale to a management buyout (MBO). For those that may not have considered it previously, even the latter could come out on top – but is the management team ready to take the next step?
The blend of low interest rates and repressed demand for funding opportunities, means there is more money available to the corporate finance market than ever before. If you are a business owner preparing an exit, this is beneficial, as the availability of cash-ready funders means more competition to aid management buyout opportunities.
Management Buyout or Trade Sale, which is right for you and your business?
For many stakeholders seeking to realise value on route to retirement, a trade sale could be seen as the most obvious course of action. However, a management buyout could be a feasible alternative to consider and is also a great way to reward loyal staff that have assisted in growing the business over the years.
Before committing to a management buyout, business owners must ensure they acknowledge the potential differences between this option and a trade sale, especially regarding valuation and deal structure. A management buyout will typically value the business at a fair and reasonable market valuation that will usually match the price paid by most third-party trade buyers. However, when there is a strategic fit, above market valuations can be achieved. . This could be where the customer base, products, intellectual property, or know-how specifically match the buyers’ acquisition criteria. Therefore, a trade sale to a buyer with a good strategic fit may realise a higher price than a management buyout but finding them may not be simple.
It is important to understand how a trade sale transaction is typically structured and comparing this to the framework of a management buyout is also a crucial part of the decision-making process. For the business owner, this involves knowing how much cash they would expect to receive on completion of the transaction and how much they would receive over time on a deferred basis, in both scenarios.
Through seeking guidance at an early stage, business owners can understand the valuation range and likely deal structures of a typical trade sale, or a sale to the management team. This understanding will considerably help business owners decide whether a management buyout is a feasible option or not.
In some cases, a business owner may not want to completely stop working and, in this situation, a management buyout could be a more appealing option. This is because the transaction could allow them to reduce their day-to-day involvement, gradually, over a period of time.
When contemplating a management buyout, forward planning is vital. In an ideal world, the current management team will be well-established and have the correct combination of skills and experience to encourage the support of a funder. For private equity firms in particular, funding decisions can often be directly linked to the quality of the management team. It is important to consider any skill gaps within the current management team and how these will be approached. It is also vital to make sure the business has a sufficient in-house, or outsourced, finance function, with strong financial management reporting and processes in place. This is crucial when planning any corporate transaction.
Whether it’s a trade sale or management buyout, business owners must consider how necessary they are to the day-to-day running of the business. The more involved they are, the more challenging it would be to exit the business smoothly on completion of the transaction. For a management buyout, a period of transition, whereby the business owner continues to stay involved, often helps to de-risk funders’ worries and can make the fundraising simpler. Additionally, if the business owner does not want to stop working completely, a period of transition may suit them. Through staying involved, the business owner can assist in ensuring the business performs well after the transaction has completed. This could be important if there is some deferred consideration at stake.
Another key consideration when planning a management buyout is timing. It is very important to acknowledge what future trading might look like and a stable, or preferably growing business is likely to captivate a greater appetite from funders. It is vital to take into account key upcoming events that could have a material effect on profitability, either positively or negatively, as these could impact the valuation and level of funding raised to support the management buyout. An example of this could be when a key customer contract is ready for renewal. In this case, it may be worth waiting until it has been secured before funding is sought as this will assist in de-risking the proposition.
Other aspects to recognize that make a management buyout more attractive than a trade sale are the due diligence and legal processes. Due diligence, often means the preferred buyer will want to thoroughly examine the company’s records before the transaction is legally completed. If the buyer is a key competitor, allowing them to access confidential and sensitive information is often a concern for the business owner that needs to be carefully managed. Through a sale to the management team the concerns are minimized as it is likely that the management team already know about the key sensitive information. From the legal side, the warranties and indemnities given by the business owner in the Share Purchase Agreement will be much simpler if the business is sold to the management team, than to a third party, making the legal process much clearer to navigate.
For the business owner, one of the most beneficial things that a management buyout offers is a high degree of control. Once the feasibility of the management buyout has been understood, valuation agreed and deal structure outlined, it’s very unusual that the transaction doesn’t go through. However, this is not always the case with a trade sale to a third party where there are much higher failure rates.
Management buyouts can equip business owners with a very inviting alternative to a trade sale and an opportunity 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 beginning, this option could be suitable for many exiting business owners in the year ahead.