AFMP4
Syllabus D. Corporate Reconstruction And Re- Organisation D2. Business re-organisation

D2c. Management buy-out (MBO) and buy-in 5 / 7

Syllabus D2c)

Advise on the financial issues relating to a management buy-out and buy-in.

Management buy-out (MBO)

A management buy-out is the purchase of a business from its owners by its managers.

For example, the directors of a company in a subsidiary company in a group might buy the company from the holding company, with the intention of running it as proprietors of a separate business entity.

Reasons for MBOs

  1. A parent company wishes to divest itself of a business that no longer fits in with its corporate objectives and strategy.

  2. A company/group may need to improve its liquidity. In such circumstances a buy-out might be particularly attractive as it would normally be for cash.

  3. A company may decide to abandon a particular product/activity because it fails to yield an adequate return.

  4. In administration a buy-out may be the management’s only best alternative to redundancy.

Advantages of MBOs to disposing company

  1. To raise cash to improve liquidity.

  2. If the subsidiary is loss-making, sale to the management will often be better financially than liquidation and closure costs.

  3. There is a known buyer.

  4. Better publicity can be earned by preserving employer’s jobs rather than closing the business down.

  5. It is better for the existing management to acquire the company rather than it possibly falling into enemy hands.

Advantages of buy-out to acquiring management

  1. It preserves their jobs.

  2. It offers them the prospects of significant equity participation in their company.

  3. It is quicker than starting a similar business from scratch.

  4. They can carry out their own strategies, no longer having to seek approval from the head office.

Problems of MBOs

  1. Management may have little or no experience financial management and financial accounting.

  2. Difficulty in determining a fair price to be paid.

  3. Maintaining continuity of relationships with suppliers and customers.

  4. Accepting the board representation requirement that many sources of funding may insist on.

  5. Inadequate cash flow to finance the maintenance and replacement of assets.

Sources of finance for MBOs

Several institutions specialise in providing funds for MBOs. 

These include:

  • The clearing banks.

  • Pension funds and insurance companies.

  • Venture capital.

  • Government agencies and local authorities, for example Scottish Development Agency.

Factors a supplier of finance will consider before lending

  • The purchase consideration. Is the purchase price right or high?

  • The level of financial commitment of the buy-out team.

  • The management experience and expertise of the buy-out team.

  • The stability of the business’s cash flows and the prospects for future growth.

  • The rate of technological change in the industry and the costs associated with the changing technologies.

  • The level of actual and potential competition.

  • The likely time required for the business to achieve a stock market flotation, (so as to provide an exit route for the venture capitalist).

  • Availability of security.

Conditions attached to provision of finance

  • Board representation for the venture capitalist.

  • Equity options.

  • A right to take a controlling equity stake and so replace the existing management if the company fails to achieve specified performance targets.

Management buy-in

- a company to an external management team

  • - is a type of sell-off which involves selling a division or part of a company to an external management team, who will take up the running of the new business and have an equity stake in the business.

  • - is normally undertaken when it is thought that the division or part of the company can probably be run better by a different management team compared to the current one.