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MBO: the cleanest way to exit your business?

Dec 03, 2020

There are many reasons why you might want to exit your business – COVID-19, Brexit, retirement – but what is the cleanest way to do it? Niall Flood explains.

As the year’s end approaches, and with the potential of good news on the horizon in the form of a COVID-19 vaccine, many business owners are taking the opportunity to consider their exit options.

This may have been on their mind for some time, or the disruption caused by the pandemic may have accelerated their thinking, but the underlying reasons are often common across would-be sellers.

These include a lack of interest from the next generation in taking over the business, or simply a desire on the part of the existing shareholders to convert the value of their shares in the business into cash to enjoy retirement fully.

It many cases, there may be difficulties in finding a suitable buyer for the business, particularly in current market conditions. Good businesses can fail to attract buyers for certain reasons. COVID-19 and Brexit are creating uncertainty – this can reduce buyer appetite and the level of acquisition activity. The number of trade buyers for certain businesses may also be limited. Many buyers are focused on finding high-growth prospects, and not every business seeking a new owner is growing at a rate of 10-15% annually.

An attractive option for business owners in these circumstances is to look closer to home and consider a management buyout (MBO). An MBO occurs when shareholders sell the business to the existing management team. This can often present a win-win scenario for both buyers and sellers.

One of the main advantages of an MBO is discretion. Owners don’t have to advertise their intention to sell, nor spend time wondering whether buyers are simply curious ‘tyre kickers’.

Another point in favour of MBOs is the potential to complete the transaction quickly. The existing management team knows the business better than any outsider and will not have to go through the usual due diligence process to complete a deal. The whole process, from inception to completion, can be carried out at pace – usually completing within six months if run properly. MBOs also have the added attraction of minimising the amount of disruption to the business during the sale process.

Importantly, there are attractions for the management team as well. An MBO allows the team to benefit more fully from the dividends and profits generated by the company. It also offers management the opportunity to have more autonomy and input into the strategy of the business. For instance, the management may wish to take the business in a different strategic direction, with a view to growing it more rapidly and selling it at a higher price in future.

Price is usually the critical factor when it comes to reaching agreement on an MBO, and there will naturally be a degree of tension between the seller and buyer in that regard. Owners will have their expectations and aspirations. The management team, on the other hand, will wish to minimise the amount they have to pay.

A lack of funding usually reinforces that desire to minimise the price. Generally speaking, management teams don’t have a lot of cash to bring to the table and will have to finance the deal through debt, private equity or deferred consideration (or a combination of all three). Naturally, they don’t want to saddle the business with too much debt.

The use of deferred consideration is a classic way to bridge the gap between the different value expectations of the seller and buyer. Under this arrangement, the management team pays a portion of the price out of future profits after the transaction closes. This can be a helpful compromise to ensure both sides get the deal done in a timely fashion – and without falling out during negotiations!

While an MBO can be simpler and more straightforward to complete than a trade sale, there is typically a requirement to have advisors involved. Advisors assist with the various elements of the deal, including agreeing on valuation, determining the funding structure, raising the money, negotiating key points, and approving the legal details. Advisors also bring a level of experience and impartiality to the transaction, which can help surmount the various obstacles encountered along the way. 

Niall Flood is a Director in KPMG Corporate Finance.