Top 10 benefits of a management buy-out over a trade sale
Wednesday, 11 September 2019
An MBO, or management buy-out, occurs when a business is sold to its existing management team. A trade sale is when a business is sold to another, often competing, business. In this blog I explain some key benefits of an MBO.
Inevitably, a trade sale requires the sharing of information to potential buyers who might include direct competitors. To provide sellers with some protection, usually confidentiality agreements are employed and any particularly sensitive business information is redacted or held back. However, this is clearly quite different to the process of sharing information with an internal management team for the purposes of an MBO. A confidentiality agreement can still be used if needed, but often the MBO team already know most things about the business as they are running it themselves.
- Warranties and indemnities
A trade buyer will, quite reasonably, insist that the sellers give them certain warranties and indemnities. Warranties are statements regarding the affairs of the business, whilst indemnities are promises to make good any specific issues identified after the business has been sold but which were incurred before that point. A breach of these usually results in a payment from the seller back to the buyer. The benefit of an MBO is that they don’t need to give as many warranties and indemnities. After all, if the MBO team have been managing the business then they should be aware of most problems, and indeed they may have even created some of them!
- Rewarding loyalty
Business owners often like the concept of rewarding their management team with an opportunity to undertake an MBO. After all, they may well have loyally served the business for many years, helped grow it, and are champing at the bit to take it over one day.
- Call their bluff!
If you sell the business to trade you will need the management team fully on board, so keeping them on side is vitally important. I’ve seen numerous instances where an MBO has been offered to the management but politely declined. That’s understandable; owning a business is quite different to working for it as an employee. In such instances, the management team are much more likely to support a subsequent trade sale. After all, they had their chance and turned it down.
- Time frame
A large part of any trade sale process is identifying and approaching potential acquirers. An MBO avoids this part of the sale process and because MBO teams should already intimately understand the business, the scope of their due diligence requirements will also be greatly reduced. The counter argument is that an MBO team may need to raise finance, but generally speaking, an MBO is often completed quicker than a sale to a third party.
Make no mistake, a trade sale is typically a deeply involved, complex and time intensive process, and the seller will bear sizeable costs accordingly. By contrast, an MBO means the sellers don’t need to market the business for sale, stripping out a layer of cost. However, as the onus is usually on the MBO team to drive the deal and incur costs themselves, it’s not unusual for sellers to underwrite or contribute to a proportion of the MBO team costs.
- Bank funding available
In case there was any uncertainty, we’ve undertaken a number of MBOs over recent years and we’ve found that banks, particularly incumbent banks, are generally very keen to provide lending. They will want to understand how the business will change after the MBO and the affordability of the repayments, but that can all be covered off in a decent business plan and financial projections.
- Reduced due diligence
I mentioned it briefly earlier, but I wanted to reinforce this point as, in my experience, due diligence is often a hugely invasive and time consuming part of a trade sale. Third party buyers, quite understandably, really want to understand what they are buying before they buy it, and want reassurance that there are no ‘skeletons in the closet’. That results in investigating accountants requesting reams of information and firing what may seem like endless questions over countless days! The sellers’ advisors should help ease some of the practical aspects of this but sellers shouldn’t underestimate the due diligence process. An MBO may still involve due diligence, particularly if a lender is involved and they need reassurance, but it tends to be much less involved.
- Timing isn’t everything
When it comes to a trade sale, timing is crucial. It’s not always a good time to sell. Any number of economic and political factors can come into play, and sometimes it’s as simple as the most likely buyer has just bought another business and doesn’t have the cash or appetite to do another deal for a certain period of time. Timing is less critical for an MBO as there are generally less external factors that are likely to have an impact.
- Future involvement
Although not impossible for a trade sale, an MBO gives sellers a great opportunity to stay involved somehow with the business after a sale has gone through, perhaps working on a part-time basis. Indeed, the MBO team may well specifically ask the sellers to remain involved and share their experience and wisdom, particularly in the early months of their ownership. This could potentially mean the sellers retain a small shareholding, or perhaps take on some sort of non-executive or chairmanship role. This may be particularly attractive to any sellers keen to remain active in their post-sale retirement.
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Next month: Top 10 tax considerations when selling a business