What is a management buyout?

A management buyout (“MBO”) is a form of acquisition where a company’s existing management team acquire a large part, or all of the company, from either the parent company or from the private owners.

MBO’s are conducted by management teams as they want to get the financial reward for the future development of the company more directly than they would do as employees only. A management buyout can also be attractive for the seller as they can be assured that the future stand-alone company will have a dedicated management team thus providing substantial downside protection against failure. This ensures their continued legacy, as well as reducing the likelihood of onerous due diligence processes being required.

Additionally, in the case of an MBO, financing for the transaction would also be more easily secured than for a transaction with a third-party seller with its own management team due to the lower underlying risk.

What financing forms are available in the event of an MBO?

1. Debt financing: The management team of a company will not usually have the money available to buy the company outright themselves. They would first seek to borrow from a bank, provided the bank was willing to accept the risk. Management teams are typically asked to invest an amount of capital that is significant to them personally, depending on the funding source bank’s determination of the personal wealth of the management team. The bank then loans the company the remaining portion of the amount paid to the seller.
2. Private equity: If a bank refuses to approve the loan, the management will commonly look to private equity investors to fund the majority of the buyout. The private equity investors will invest money in return for a proportion of the shares in the company, though they may also grant a loan to the management. The exact financial structuring will depend on the backer’s desire to balance the risk with its return, with debt being less risky but less profitable than capital investment.
3. Seller financing: In certain circumstances, it may be possible for the management and the original owner of the company to reach an agreement whereby the seller finances the buyout. The price paid at the time of sale will be nominal, with the real price being paid over the following years out of the profits of the company. The timescale for the payment is typically 3–7 years.

Management buyouts, therefore, clearly represent a method whereby an owner can exit their business and realise a further return on the initial investment made when putting standard operating procedures in place.

The legal, taxation and commercial considerations required when planning a management buyout could be cumbersome and we would recommend careful planning well in advance should this be an option for you or your company.

If you have any questions, please contact Arnold Scholtz at arnold@asl.co.za