Making a management buyout the most attractive deal on the table

A management buyout (MBO) can simultaneously improve the fortunes of both the business and its managers.

Management-level personnel can often find their career progression is stunted by a proverbial glass ceiling. With no promotions left to work towards and only a limited control over the company, it can be tempting for management to look elsewhere for new opportunities. However, an MBO can provide the next step a manager needs towards controlling his or her destiny. At the same time, having the resources to back the strategic direction of their expert ‘insider knowledge’ of the company and the industry can make a huge difference to the success of the company.

The benefits of an MBO
By joining together with other senior members of staff and arranging financial backing, a management team can often stand an excellent chance of buying the business they are working in. By doing so they stand to benefit in a number of ways.

Firstly, an MBO can deliver substantial financial gains. Rather than collecting a salary, taking a sizeable stake in the business can mean far larger returns. If the managers’ strategy for growth proves successful they will share in the profits – this is particularly true if their goal is to grow the business for a future sale.

Earlier this year an MBO was completed at Fife-based steel manufacturing firm Pipe and Piling Supplies (PPS). It serves as an example of how quickly a business can grow following an internal takeover.

PPS managing director Alistair Cochrane led the buyout. He joined the business seven years ago and had overseen steady expansion that took the supplier from a turnover of £1.59 million in 2008 to £8 million in 2014 – following the MBO it is forecasting £20 million of sales in this current financial year.

These extra profits do not just translate into larger dividends for the owners; it also increases the price the business would be likely to fetch in a business sale.

Furthermore, an MBO is also a means of shattering the aforementioned glass ceiling and giving a manager hands-on entrepreneurial experience. The team involved in the buyout will suddenly find themselves holding the reins, a position that will enable them to gain valuable knowledge of how to steer and grow a business.

Another benefit of an MBO is that those involved gain greater job security. Management personnel are more secure than employees on lower rungs of the ladder, but their fate is still in the hands of someone else – namely, the business owners. By completing a financial takeover of the company, an individual can fortify their position and focus on long-term strategic growth. Of course the risks of keeping the business afloat are still very much in play, but at least the managers are no longer vulnerable to the whims of an owner who has no real loyalty towards them and who may be less in tune with the company.

The best way to grow the business
But it is not just the management team that stand to benefit from the greater entrepreneurial and financial control provided by an MBO – the business can also benefit from a buyout rather than a trade sale. The aforementioned MBO at PPS is evidence of this.

The benefits stem from the fact that a takeover by a group of existing managers will provide much greater consistency and stability. This differs from a takeover by an external party, such as a management buy-in (MBI), in which a manager or management team from outside the company raises the necessary finance, buys it, and becomes the company's new management.

Moreover, the management team ought to have a comprehensive understanding of the business, its partners and customers, and the market it operates in; not to mention a developed strategy for future success. This improves the chances of quick growth while lessening the odds of disruption that could damage the business.

The MBO at motor finance technology specialist Codeweavers in November 2015 provides a good example of this. Managing director Roland Schaack led the buyout and said afterwards: “The management buyout sees the key people who currently lead the business taking an active stake in our future.

“For our customers and prospective customers, continuity and commitment are further enhanced. As a business, this same assured continuity strengthens our long term plans and growth momentum.”

Indeed, the extra stability provided by the management team’s insider knowledge, as mentioned here, also makes it easier to gain investment; funders will often look favourably on an MBO rather than a takeover because there is less uncertainty and therefore lower risk.

Weighing up an MBO
Despite the benefits an MBO can provide for the managers and the business alike, this is not to say it is always the best option. As with any merger or acquisition, due diligence must be taken to assess whether or not a deal should go ahead.

For an MBO to prove successful, one must first ensure that the business already has a solid track record of profitability. A management team will have a vision for how to grow the company further, but if the business is not already turning a profit then the evidence suggests there are fundamental issues.

The team involved must also possess the right skills and experience. It is easy for a group of managers to assume they could do a better job than the business' existing owners, but without the right collective skills and experience this will likely not be the case.

Assuming these fundamentals are in place, an MBO might be feasible. The next step is to approach the vendor – the individual or group from whom the management team would be buying the business – to see if they would be receptive to a sale. Needless to say, this must be handled in a sensitive manner. An empathetic understanding of the owner is a must and questions need to be asked before jumping in with an offer. Is the owner an individual who is approaching retirement? Are their trade buyers out there hungry for an acquisition? Is the business a non-core operation owned by a corporate? Are the owners hungry for cash or more interested in receiving more for their business over two or three years in the form of an earn-out?

Financing an MBO
If the pieces are in place for a buyout to go ahead, then the management team is going to need financial backing.

The managers will require funding for the price of the business as well as the administrative costs associated with an MBO. However, because of the insider knowledge and personal connection the buyers have with the seller, both of these expenses will often be lower than in a normal business acquisition.

Nevertheless, financing an MBO is usually the main obstacle to getting the deal done. There are, however, several ways managers can get the necessary backing. And while the managers themselves often only put a small amount into the funding pot, the rest often comes in some form of bank debt, such as loans. Whilst bank finance is usually the cheapest source, banks often have strict rules that must be adhered to - the flexibility is not there if your financial requirements or situation changes.

Alternatively, managers can use deferred consideration, in which the exiting shareholders lend back to the company a proportion of the consideration for a period.

Venture capital – or VC – funding is another option. VC companies can provide the necessary cash injection to the management team with a view to taking a stake in the company, all on the premise that the business' value will grow over the following years and thus they will see a positive return on their capital.

As when securing funding for any type of business acquisition, or business venture for that matter, the management team will need to demonstrate their own credentials, prove that the business they want to take over is commercially viable, and deliver a developed strategy for future growth.

Greater power, greater profit
Management buyouts are not free from risk or difficulties, but they do represent a safer option than a standard business takeover. What’s more, an MBO often provides a much simpler and quicker route to growth.

Therefore, if the vision, passion and skills exist within the management team to take their business to new heights, then an MBO is well worth exploring. And by taking up ownership of the company, managers can control their own futures and enjoy the greater power and profit that comes with their elevated position.

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