Inspecting Management Buyouts

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In the center of this week’s discussion are management buyouts. What are they? Management buyouts (MBO) are a transactional process whereby a company’s management team purchases the assets and operations of the business they manage. An MBO proposes an incentive to professional managers because of the greater potential rewards from being owners of the business rather than employees. This kind of process is a favored exit strategy for large corporations who wish to pursue the sale of divisions that are not part of their core business, or by private businesses where the owners wish to retire in the near future. MBOs are quiet cost intensive and usually require a combination of debt and equity (known as mezzanine financing) to be derived from the buyers, financiers and sometimes the seller.1

The process typically begins with the manager or management team asking for a loan. The shares and stocks of the acquired company then act as a guarantee. The loan is then repaid via the purchased firm’s generated future cash flows.

Another way of performing the MBO is together with a private equity firm. This kind of deal entitles the private equity firm to take on the role of providing the financial guarantees and to participate in the strategic management of the company to divest with profits after the specified time, normally about five years.

There are several types of MBOs:

BIMBO (Buy In Management Buy Out): an acquisition of a company performed by both its own management team and by outside managers. Essentially, this transaction is the intersection of the two methods: Management Buy Out (MBO) and Management Buy In (MBI).

EBO (Employee Buy Out): in this transaction, the property acquired and passed to the entire employee workforce, supported by a financial investor. This type of buyout is known as the least frequent one.

OBO (Owners Buy Out): during this negotiation, the owner of the company sells it to a private equity firm but will eventually maintain a small percentage to sell at the time when the private equity firm sells.

The Right Fit: 

It is important to note that not all companies are suited for these kinds of transactions. Here are some characteristic requirements for a company to be viable for a buyout:

1. The Company should be profitable – or have a great potential for generating future profits.

2. The company’s income statements and balance sheets should be in order – not to say that they shouldn’t be ordered at all times, but for a company to be ready for a buyout procedure, it should acquire little debt, where the financing will come from the seller (vendor finance) or via a bank loan.

3. The company should not require any important investment – investments are always encouraged, but during a potential buyout, the company should focus on allocating its funds towards interest payments and paybacks of any debt that was required to buy the company.

The targeted firms for an MBO process are therefore cash cows – firms with little debt and significant profit generating assets that will guarantee future financing and repayment of accumulated debt.


References:

Picardo, E. (2018). Management Buyout – MBO. Retrieved from https://www.investopedia.com/terms/m/mbo.asp

Quemada Clariana, E. (2018). How to Maximize the Value of Your Company [Ebook] (p. 196). Retrieved from https://www.amazon.com/How-sell-your-business-maximize-ebook/dp/B00APJGW1C


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