What Is a Management Buyout (MBO)?
The term management buyout (MBO) refers to a financial transaction where someone from corporate management or the team purchases the business from the owner(s). Management members that execute MBOs purchase everything associated with the business. This type of buyout appeals to professional managers because of the greater potential rewards and control from being owners of the business rather than employees. The MBO is a type of leveraged buyout (LBO), which is an acquisition funded primarily with borrowed capital.
- A management buyout is a transaction where a company’s management team purchases the assets and operations of the business they manage.
- MBOs generally occur to take companies private in an effort to streamline operations and improve profitability.
- A management team pools resources to acquire all or part of a business they manage.
- MBOs are financed with a mix of personal resources, private equity financiers, and seller-financing.
- A management buyout is the opposite of a management buy-in, where an external management team acquires a company and replaces the existing management.
How Management Buyouts (MBOs) Work
As noted above, management buyouts occur when a corporate manager or team acquires the business they manage from the owner(s). The business is purchased from a private owner and/or any shareholders in the company. The acquisition includes everything associated with the business, including the assets and liabilities. MBOs often take place because the management feels they are better equipped to help the company grow and succeed financially. These transactions are key exit strategies for:
- Large corporations that want to sell off unprofitable assets or those that no longer make sense
- Private businesses where the owners wish to retire
The financing required for an MBO is often quite substantial and is usually a combination of debt and equity that is derived from the buyers, financiers, and sometimes the seller. Since it uses a significant amount of borrowed capital, it is considered an LBO. As such, it may also be called a leveraged management buyout.
While management reaps the rewards of ownership following an MBO, they have to make the transition from being employees to owners, which comes with significantly more responsibility and a greater potential for loss.
Reasons for an MBO
Management buyouts are risky ventures. That's because they may or may not work. So why would a company's management consider doing one? The following are some of the main reasons that corporate management may consider undertaking an MBO.
- Gaining control. Members of management may not agree with the direction of the company. By executing an MBO, they may feel as though they have more control of the business, its success, and its future.
- Financial gain. Members of the management team may not feel as though they aren't getting the full financial benefit just by managing the company. By acquiring the company, they can reap the benefits.
- They have the expertise. Management may feel as though the owner(s) doesn't have the knowledge or ability to lead the company. Corporate management may have the educational or work experience to help them guide the company to new heights and they may feel that the only way to do that is through an MBO.
How to Approach a Management Buyout
A successful MBO requires a great deal of planning and preparation. As such, it should never be undertaken hastily. The following are a few factors that should be considered in the process.
Considerations Before the MBO
Any type of financial transaction should be well-researched. As such, management should craft a plan or proposal that's fully thought out and conceived. Some points to add include:
- The members of the management team involved in the MBO
- The reasons for the buyout
- The intentions and goals after completion
- The terms of the deal, including the purchase price
- The way the buyout will be financed
It's always a good idea for management to show the company's owner(s) that they've done their homework. This includes adding in spreadsheets and doing a thorough analysis.
A significant amount of money is required for an MBO because of the sheer size. There are a few different sources that management can turn to in order to secure capital for the deal:
- Debt: Management normally turns to banks and other lenders to secure financing. Banks tend to consider MBOs to be fairly risky ventures, so they may not fund part or all of management's requests. This means the buyers may have to look for primary funding elsewhere before they turn to a lender to cover any shortfalls.
- Private Equity: Private equity firms are usually receptive to finance MBOs if banks refuse. One thing to keep in mind is that these firms often expect to get a share of the company even though they're loaning the money to management.
- Other Types: There are some other types of financing that are used by management, including owner financing, which is funded directly through the seller who is repaid, or mezzanine financing, which involves a combination of debt and equity.
Management should do their due diligence while considering an MBO. This includes a full evaluation of the company and its financial and legal framework.
Advantages and Disadvantages of an MBO
Management buyouts are considered good investment opportunities by hedge funds and large financiers, who usually encourage the company to go private so that it can streamline operations and improve profitability away from the public eye. They are encouraged to go public at a much higher valuation down the road.
A private equity fund that supports an MBO will likely pay an attractive price for the asset, provided there is a dedicated management team in place.
There are several drawbacks to the MBO structure as well. While the management team can reap the rewards of ownership, they have to make the transition from being employees to owners, which requires a change in mindset from managerial to entrepreneurial. Not all managers may be successful in making this transition.
The seller may also not realize the best price for the asset sale in an MBO. The managers have a potential conflict of interest if the existing management team is serious about bidding on the assets or operations being divested, Put simply, they could downplay or deliberately sabotage the future prospects of the assets that are for sale to buy them at a relatively low price.
Good investment opportunity for management and private equity/hedge funds
Private equity funds may pay a good price depending on the circumstances
Transition for owners and employees may be tough
Can result in a conflict of interest
Management Buyout (MBO) vs. Management Buy-in (MBI)
The opposite of an MBO is a management buy-in (MBI). While an MBO involves a company's internal management purchasing the operations, an MBI takes place when an external management team acquires a company and replaces the existing management team. MBIs involve companies that are led by poor management teams or are undervalued.
An MBO’s advantage over an MBI is that as the existing managers are acquiring the business, they have a much better understanding of it and there is no learning curve involved, which would be the case if it were being run by a new set of managers. MBOs are conducted by management teams that want to get the financial reward for the future development of the company more directly than they would do only as employees.
While private equity funds may participate in MBOs, their preference may be for MBIs, where the companies are run by managers they know rather than the incumbent management team.
Example of an MBO
One prime example of a management buyout involves the computer and technology company, Dell. In 2013, founder Michael Dell and a private equity firm (Silver Lake Partners) paid shareholders $25 billion as part of a management buyout. Dell took the company private, so he could exert more control over the direction of the company. The company went public again in December 2018. Shares trade on the New York Stock Exchange (NYSE) under the ticker symbol DELL.
How Do Management Buyouts Work?
Management buyouts work when one or more members of a company's management team want to buy the operations from the owner(s). The goal is to take the company private to help it grow and succeed. These buyouts are typically funded with one or more types of financing, including debt and equity.
What Is an Example of a Management Buyout?
In 2013, Michael Dell partnered with a private equity firm to purchase the computer/technology company he founded from shareholders. He took Dell private before the company went public again in 2018.
How Do You Finance a Management Buyout?
There are a number of ways to finance a managed buyout. Debt financing involves going to banks and other lenders for loans. But banks may not consider financing these types of deals because of the amount of risk involved. Private equity firms, though, are more receptive to loaning money to management. Some companies may require a share in the company in addition to being repaid. Buyers can also approach owners/sellers for loans or use a combination of debt and equity to pay for the acquisition.
The Bottom Line
Mergers and acquisitions are a big part of the corporate world. It isn't uncommon to hear about takeovers, vertical mergers, and management buyouts. MBOs involve corporate management putting in an offer to purchase part or all of the business they manage. The goal is to take it private so it can continue to grow. Even though they take place in corporate America, MBOs are also fairly common in the small business world—usually when the company exchanges hands from one generation to the next.