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Home > Mergers and Acquisitions Checklists > Management Buyouts

Mergers and Acquisitions Checklists

Management Buyouts


Checklist Description

This checklist outlines what constitutes a management buy-out (MBO).

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Definition

A management buyout (MBO) is the acquisition of a business by its management. The management will usually buy the target business from its parent company. The management will incorporate a new company to buy the business or shares of the target company. The transaction usually involves another party, a venture capitalist, which, together with the management, will invest in the new company. A venture capitalist is a company or fund that invests in unquoted companies. The investment usually takes the form of an equity stake.

In an MBO it is very important to establish whether the parent company, the vendor, is willing to sell. The management are usually in a very good position to buy, since they already understand the business they intend to acquire. Funding the acquisition usually requires not only the personal financial commitment of the managers but also additional funding in the shape of a loan or an equity investment.

It is essential that the management establish a coherent business plan, which will help not only in obtaining the funding required for the MBO but also in convincing the parent company that the managers are the best buyers for the business. As for investors, what they need is assurance that the business will be able to continue successfully and that it will provide them with a profitable return on their investment.

In an MBO, confidentiality while negotiations are taking place between the parent company and the management team is essential. The consequences of a leak could be damaging to the business and its staff.

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Advantages

  • An MBO will give the management the chance to run their business.

  • The new company will have a highly motivated management team, who are not only eager to make a profit but also have a deep knowledge of the business they will be running.

  • Since the management understand and have been involved in the running of the business to be acquired, the commercial due diligence that is usually undertaken when a company is acquired should be easier and less time-consuming.

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Disadvantages

  • An MBO involves a very serious financial commitment and acceptance of risk by the management. The management will move from being employees to being owners of the business. If the business is not successful, they will feel it directly.

  • Even though the commercial due diligence required could be less extensive, the legal and financial affairs of the business still need to be examined. This will involve advice and expense.

  • Since acquisition by an MBO is highly leveraged (i.e. has a high proportion of debt relative to equity), this does not put the new company in the best position to compete on price.

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Action Checklist

  • Think carefully about the business before you acquire it. Obtain as much information from as many sources as you can before committing to an expensive due diligence process.

  • Know your market and make sure that you have analyzed the consequences of owning your own business.

  • Be prepared for a long and complicated due diligence process, which could prove time-consuming as well as costly.

  • Economize by negotiating a reasonable rate with your legal and financial advisers, but remember that it is better to incur costs by conducting a thorough investigation than to accept a level of service that may fail to reveal potentially costly liabilities.

  • Always be aware of confidentiality while the MBO is being planned, as any leak can affect the confidence of the staff and affect the performance of the business.

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Dos and Don’ts

Do

  • Involve your lawyers and accountants in the evaluation of both the risks and potential benefits of an MBO, as well as in the due diligence process.

  • Negotiate your rates and make a contingency plan for any cost overrun.

  • Draw up an accurate and achievable business plan.

Don’t

  • Don’t make the mistake of being attracted by the idea of owning a business without fully weighing up the risks you might be taking.

  • Don’t underestimate the importance of finance and the financial commitment that owning a business will entail. The risks to the owners of a business are high if the business does not perform.

  • Don’t forget that many of the banks that offer finance will be looking for collateral for the loan, and the managers could be required to provide personal guarantees that will affect their personal wealth if things do not work out.

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Further reading

Books:

  • Sharp, Garry. Buy Outs: A Guide for the Management Team. London: Euromoney Institutional Investor, 2002.
  • Wright, Mike, and Hans Bruining. Private Equity and Management Buy-Outs. Cheltenham, UK: Edward Elgar Publishing, 2008.

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