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If you're a manager looking to acquire a business, you should be familiar with these increasingly popular exit strategies used by business owners – MBO, or Management buyout and LMBO, or Leveraged Management buyout. In its simplest form, an MBO involves a management team pooling resources to acquire all or part of the business that they manage. LMBO is similar to MBO, except the buyers use company assets as collateral to secure financing.
Most of the time, the management team takes full control of ownership, using their expertise to grow the business. An MBO/LMBO acquisition, which can be sizeable, is usually funded by a mix of personal funds, external financers and the seller.
There are several advantages to consider with an MBO/LMBO:
- Internal process and transfer of responsibilities remain confidential and are often handled quickly.
- Continuity with the company's business therefore reducing risk.
- Experienced management team understands the needs of the business.
- Reassures company's existing clients and business partners.
- Opportunity to obtain interesting return on investment.
MBO/LMBO are not to be confused with a:
- Management buying (MBI): a team of outside managers buys the business, often with financing from private equity investors.
- Buyin-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.
Things to consider
Be transparent: approach the owner with your proposal and ask for permission before you disclose confidential information to financers.
Check the feasibility of the initiative: ensure the venture is profitable. Keep in mind MBOs/LMBOs require substantial financing, that will impact company cash-flow. You'll 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 you valuable information on the fair market value of the business and the management's operating flexibility. Avoid buying too high even if you have a personal stake.
Choose your management team well: you will need to have the right combination of skills to take the company through a transition period and run the business profitably.
Establish a fair share of equity: there should be incentives for everyone involved in the process.
Remain low-key: keep a low-profile until the paperwork is signed. You don't want to reveal your interests and instigate an auction, which may cause the price to rise.
Retain good relationships: if your MBO/LMBO fails, you may end up working with the same colleagues in the future.
Series of common steps for transfer of power:
- Buyer and seller agree on a sale price, that may result in a win-win transaction.
- A valuation of the business confirms the agreed upon price.
- Managers assess the portion of the shares they could purchase immediately and draft the shareholder agreement.
- Financial institutions are approached.
- A transition plan is developed that incorporates tax and succession planning.
- Managers buyout the owner's 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 point in time and at a pace that will not unduly slow down the growth of the business.
How to finance an MBO/LMBO
Be sure that you develop a strong business plan to prepare your acquisition. Your forecast should be credible and realistically attainable so your partners and you know what you're getting into. Personal or business contacts or referrals can also help you secure confidence from bankers. In a small buyout, usually a single institution is involved. In larger transactions, several institutions may handle the financing.
In LMBO, business assets are evaluated to determine 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 risks associated to the transaction.
The financer may ask the seller to finance a portion of the sale as a form of commitment to the venture as well as a reflection 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 realize your venture:
Personal funds can help secure confidence from a financial institution, ad equity to the transaction and share risk. Managers often need to invest a significant amount of personal money, such as refinancing personal assets, in order to demonstrate their commitment.
Loan or credit notes from banks are often used to purchase shares from an owner. This type of financing is attractive because of its simplicity: assets are being used as collateral and interest rates are lower.
Seller 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 is 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 both debt financing and equity financing without diluting ownership. If a profitable business maximized the financing on their assets and the management team's personal funds are insufficient, 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 industry insight and expertise, however the buy back cost remains undetermined.
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