Management buyout finance and step-by-step plan
Reading time 4 min.
Selling a company
Step-by-step plan for management buy-out
If you want to know how a management buy out works, this article will help you. As a manager, you are passionate about the company you work for. You know the company inside out and see opportunities for growth. When the current owner decides to step down, a takeover by the management team could be a very interesting opportunity. In this article, we explain what this type of takeover involves, what the advantages and disadvantages are, how the financing works, and we conclude with a calculation example.
What is a MBO strategy?
A management buyout (MBO) is a form of acquisition in which ( a part of) the shares of the owner are acquired by the current management. This MBO strategy is becoming increasingly common and, with unique opportunities for both the seller and the manager, offers a good alternative to family succession or sale to an external party. An important part of a management buy out is the financing, for which there are various options. An external advisor can help you determine the most favourable approach.
Why is this interesting for sellers and management?
A seller considers a management buy out to be a suitable option if there is no successor within the family or if he does not want to sell to “competitors”. There is also often a relationship of trust with the management and therefore a high degree of goodwill. As a manager, it is interesting to take over the company because you have a good idea of the growth opportunities and have already built strong relationships with employees, suppliers and customers. Together with your team, you ensure continuity of the company’s values and activities and a smooth transition for all parties involved. In addition, a takeover is often the final career step within the company and therefore an attractive move to realise your full potential.
What are the disavantages?
The transition from manager to owner is a significant step, as ownership suddenly involves much more direct involvement in the growth of the organisation. Friction may arise between the manager and existing staff due to jealousy. This can lead to a lack of commitment or motivation. In addition, management buy out finance is a special form of acquisition, in which the interests of the parties are sometimes diametrically opposed. Maintaining the relationship is important, and for that reason it is wise to engage an independent advisor for financial mediation. This advisor takes a businesslike view of the process, without losing sight of the emotional aspects, and makes sure there’s a pleasant outcome.
The 9 management buy out steps
A MBO strategy involves slightly different steps than a normal company takeover process. The following management buy out steps are the most important:
- The seller and management jointly express their desire for a management buyout.
- An independent expert values the company.
- Negotiations on price and conditions.
- Preparation of the financing memorandum.
- Newco (a new private limited company to be established) purchases 100% of the company’s shares. Before bank financing can be obtained, the correct legal and tax structure must be established.
- Newco obtains the maximum achievable bank financing.
- Contribution of own funds and obtaining any other financing, such as a vendor loan.
- If there are multiple shareholders, a shareholders’ agreement is drawn up.
- A solicitor records the transaction.
Management buy out finance
To finance a management buy out, a manager contributes his own capital, but this is often not enough to pay the full purchase price. He therefore obtains funding from a bank or investors, or borrows from the current owner. For example, you could opt for a leveraged buy-out, whereby the acquisition is mainly financed by borrowed money. You repay the loan from cash flow, using your company’s assets as collateral.
A major advantage for management buy out finance is that a relatively small capital contribution can result in a large shareholding, which often makes the purchase price easier to finance than initially thought. Interest and tax benefits can be used to create a return lever. This leverage ensures that a high return can be achieved with a small investment of equity capital. We explain this in the following calculation example.
Calculation example
The following assumptions were used in the management buyout example:
Net profit: €100,000
Price/net profit ratio: 5
Purchase price of the company: €500,000
Example 1: financing with equity capital
The manager finances the entire purchase price with equity capital. The return on equity capital is 20% (€100,000/€500,000).
Example 2: equity and loan capital
The manager finances the purchase price with €200,000 of equity capital and €300,000 of loan capital. The loan capital consists of €200,000 in bank credit and €100,000 in loans from the selling party. The manager has to pay a relatively high interest rate of 5% (net after tax) on the loan capital. The interest charges amount to €15,000.
The return on equity is now 42.5% (€100,000 – €15,000/€200,000). This shows that the return can be increased with borrowed money. However, this financial leverage is subject to tax rules. As a result, the interest is not always tax deductible.
BrightOrange for independent management buyout advice
A management buyout is a complex process. It offers a great opportunity, but can also have serious consequences for the relationship between management and the current owner. BrightOrange advises and guides you on both a personal and professional level. We act as an independent valuation specialist and acquisition advisor at every step of the process. Thanks to our mediation expertise, we have extensive experience in guiding processes that safeguard the interests of both parties. Feel free to contact one of our partners or consultants for no-strings-attached advice.
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