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As a business owner, you should be familiar with the term "MBO," as an exit strategy and an alternative entry strategy for potential entrepreneurs. If you're an owner looking to sell your business, an MBO (Management Buyout) or an LMBO (Leveraged Management Buyout) may be interesting options. In its simplest form, an MBO involves the management team pooling resources to acquire all or part of the business that they manage. The LMBO is similar to the MBO, except that the buyers use company assets as collateral to secure financing.
Most of the time, the management team takes full control and ownership, using their expertise to grow the business. An MBO/LMBO acquisition, which can be sizeable, is usually funded by a mix of personal investors, external financiers and the seller.
The MBO/LMBO offers several advantages:
- The internal process and transfer of responsibilities remain confidential and are often handled quickly
- Continuity with the company's business reduces risk
- Experienced management team understands the needs of the business
- Reassuring to the company's existing clients and business partners
- Offers an opportunity to obtain interesting return on investment.
MBO/LMBO are not to be confused with a:
- Management Buy-In (MBI): a team of outside managers buys the business, often with financing from private-equity investors.
- Buy-In Management Buyout (BIMBO): a combination of MBO and MBI, where an external group of managers buys into the business and joins forces with the internal management team.
What buyers are looking for
Transparency: The seller may be approached with a proposal and choose to grant permission before the buyer discloses confidential information to financers.
Feasibility of the initiative: A buyer will need to ensure that the venture is profitable. Keep in mind that the MBO/LMBO requires substantial financing, which will impact on company cash flow. The buyer will need a strategy to compensate for the repayment, such as cost-cutting, improved productivity and increased revenues.
A thorough financial analysis should reveal cash flow, sales volume, debt capacity and potential for growth. This will provide valuable information on the fair market value of your business and on management's operating flexibility.
A good management team: The buyers will need to have the right combination of skills to take the company through a transition period and run the business profitably.
Fair share of equity: There should be incentives for everyone involved in the process.
Remaining low-key: The buyers will want to keep a low profile until the paperwork is signed.
Good relationships: If the MBO/LMBO fails, the potential buyers may end up working with the same colleagues in the future.
Common steps in the transfer of power:
- Buyer and seller agree on a sale price
- A valuation of the business confirms the agreed-upon price
- Managers assess the portion of the shares they could purchase immediately, and then draft the shareholder agreement
- Financial institutions are approached
- A transition plan is developed, that incorporates tax and succession planning
- Managers buy out the sellers' interest with financial support
- Decision-making and ownership powers are transferred to the successors; this can take place gradually over a period of a few months or even a few years
- Managers pay back the financial institution. This is done at a time and at a pace that will not unduly slow the growth of the business.
How to finance an MBO/LMBO
The successor(s) will need to develop a strong business plan to prepare for the acquisition. The forecast should be credible and realistically attainable so that everyone knows what they're getting into. Personal and business contacts and referrals can also help a successor secure confidence from bankers. A small buyout usually involves only one institution. In larger transactions, several institutions may handle the financing.
In an LMBO, business assets are evaluated to determine the equity available for financing. The lender will use the assets as collateral and refinance the remaining portion. The financial institution will adjust interest rates according to the risks associated with the transaction.
The financer may ask the seller to finance a portion of the sale as a form of commitment to the venture, and as a sign of confidence in the management team. Be sure to shop around for the best terms.
Here are some basic types of financing that may be combined to achieve a successful transition:
Personal funds can help secure confidence from a financial institution, add equity to the transaction and share risk. Buyers often need to invest a significant amount of personal money—which may involve refinancing personal assets—in order to demonstrate their commitment.
Loan or credit notes from banks are often used to purchase owner shares in the business. This type of financing is attractive because of its simplicity—assets are used as collateral—and because interest rates are lower.
Seller/owner financing can extend payments over a number of years. This form of financing is tied directly to the seller and may include credit notes, loans or preferred shares. This may reduce cash outflow at time of transaction, and make the transition easier.
Similarly, an installment purchase of stock allows the seller to maintain a level of control until he's completely paid off.
Selling stock to employees can be used in conjunction to an MBO/LMBO to finance the remaining portion. Employee Stock Ownership Plan Association explains how this type of financing enables other employees to purchase stock options in the business. This can give incentive to existing employees, while the management team retains control of the business.
Subordinate financing can complement a management team's equity investment by bringing together some features of debt financing and of equity financing, without diluting ownership. If a profitable business maximizes the financing on its assets and if the management team's personal funds are insufficient, then subordinate financing may take on a higher risk to participate in the venture. Repayment terms are established at time of transaction.
Venture capital can provide long-term, unsecured equity financing. The investment structure is based on a partnership, where the venture capital group purchases shares in the business in exchange for ownership rights. Repayment is not fixed, as the exit strategy is generally realized out of the capital gain or the increase in the company's share value. Venture capital investment provides the owners with industry insight and expertise; however, the buyback cost remains undetermined.
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