Considerations in a Management Buy-Out – Part 1: Striking a Balance
A management buy-out (“MBO”) is an effective succession/exit strategy where an Owner wants to reward its core management with an equity stake in the business for the future, while being able to crystalize their own investment.
Many owners see a MBO as a viable option as the Management Group is generally sophisticated with respect to the operations of the business, which may lead to a shorter sell-side timeline (they know the cyclicality of the business, its people, infrastructure, and the market - which limits the due diligence process). In addition, the owner can maintain greater confidentiality of the deal.
A MBO may not work if the highest priority of the Owner is achieving the greatest value, as the Management Group may not have access to the same amount of capital as a strategic or financial purchaser, and because of this capital limitation, the Owner is often required to finance part of the purchase price through a vendor take-back (“VTB”).
Success is generally seen when the following criteria are met:
In summary, success is achieved by a balance of valuation expectations, financing, and the structure of the deal.
- Valuation needs to be reasonable enough for the Company to be able to service the buy-out financing via its ongoing operations.
- Financing is typically done through a combination of debt and equity, whereby the Management Group will try to seek out the cheapest source of financing first (i.e., commercial bank/senior debt) and may need to layer in mezzanine debt (sub-debt) financing which would be subordinate to the senior debt (thereby costing more). As well, the Management Group typically needs to show commitment to the transaction by injecting their own capital for the deal to be successful.
- The right structure will properly reward the Owner and will not create undue financial risk for the Management Group (i.e., inability to make loan payments).
The ultimate deal structure will be determined once the value of the Company has been determined and financing options are known.
Stay tuned for our next article on some possible MBO deal structures.