Guide To A Management Buy-Out - Introduction

A comprehensive guide to allow management teams to understand how to undertake a management buy-out

Ali Robertson

Managing Director

e: ali.robertson@eclipsecf.com

m: +44 (0)7835 064 321

A Management Buy-out ("MBO") is the acquisition of a company by its core management team, usually in conjunction with a combination of third party finance providers such as private equity funds, banks and debt funds.

 

MBOs are an excellent form of succession planning for businesses where the existing shareholders are looking to retire, but want to ensure continuity and a safe home for their business going forward.

 

For the management team, it provides a once in a lifetime opportunity to own the business for themselves and create value which can be crystallised through a future sale.

 

The process and structuring of an MBO is complex and time consuming, so the use of a specialist corporate finance advisor is strongly recommended. Eclipse has significant experience in structuring and delivering successful MBOs in a range of difference scenarios.

I hope you find this guide useful, but if you have any queries or would like to discuss how Eclipse can help you either now or in the future, please don't hesitate in contacting me.

The Parties Involved

Alignment between the management team, vendor and funders is vital to undertake a management buy-out

Management

The management team involved in an MBO is a small group of three or four senior executives which generally includes:

  • Chief Executive

  • Finance Director

  • Commercial/Sales Director

  • Operations Director

 

The team's objectives are to agree a deal with the vendor, raise the necessary funding to complete the transaction, and ultimately to maximise their returns.

Finance Providers

In most scenarios, the management team will not have sufficient resources to fund the purchase price themselves. Most transactions will therefore require the use of funds from a private equity house, bank, alternative debt provider, or a combination of these sources.

Prior to committing to funding a transaction, they will look to ensure that the management team is competent and that the business plan is robust and deliverable.

As with management, the key objective of these parties is to maximise the return on their funds. 

Vendor

As previously mentioned, an MBO provides an excellent option for vendors looking for a deliverable deal which secures the future of the business and its employees.

Whilst finding a good home for the business is clearly important, the vendor will also be looking to maximise value from the sale.

Furthermore, they will strive to minimise the warranties and indemnities provided upon sale, to reduce the risk of any future claims from the new owners.

Approaching The Vendor

Obtaining the vendor's permission to begin negotiations and seek funding is a vital step

The first key step in completing a successful MBO, is for the management team to approach the vendor (or vice versa). Whilst this is clearly a sensitive area which needs to be managed carefully, it is vital that both parties ​put their cards on the table to avoid disagreements or difficulties at a later date.

Once it is clear both parties are open to the possibility of an MBO, the next step is to agree the key terms of a deal. In doing so, the management team must come up with an offer which is acceptable to the vendor, but will also allow sufficient returns to be generated for themselves and any external funders. 

The use of an experienced corporate finance advisor is highly useful in this regard, providing the ability to prepare financial models and run scenarios to assess the feasibility of an MBO at various price points.

After agreeing the key terms of a transaction, it is advisable to reflect these in a detailed set of Heads of Terms. Doing so provides clarity and protection for both the vendor and management team.

Creating A Business Plan

A detailed business plan is essential in obtaining the necessary funding for a transaction 

In order to obtain the necessary funding to complete an MBO, a comprehensive business plan will be required. 

The content and assumptions within the plan will need to be sufficiently robust to withstand the diligence process. The plan will usually take the form of written document, underpinned by a detailed financial model. An example document structure is as follows:

1. Executive summary: a high level overview of the business and plan.

2. The Market: analysis of the market trends and details of competitors.

3. The Business: a summary of the key commercial elements of the business, including details of customers and suppliers.

4. People: an overview of the management structure and staff within the business.

5. Operations: a summary of the day to day operations of the business, in addition to details of properties and sites utilised.

6. Strategic Plan: details of how you plan to grow the business in the future.

7. Financial Information: a summary of the key historic and forecast financials.

8. Exit Strategy: views on who the business could be attractive to in the future (private equity, IPO, trade acquirers).

Obtaining Finance

A range of finance options are available to fund management buy-outs

Financing Options

A range of different financing options currently exist within the market to meet the needs any given transaction. These include the following:

1. Bank debt: this may include bank loans, overdrafts, or invoice discount facilities and may be secured or unsecured. Pricing varies based upon the risk profile of the debt provided.

2. Private Equity ("PE"): the majority of PE funds seek to invest in established, expanding companies that can generate significant investment returns (25%+). They invest in the form of equity and loan notes (a debt instrument) and will look to be involved in the operations of the business, appointing members to the board of the company.

3. Debt funds: a range of alternative debt providers exist, providing solutions to meet a variety of different needs, including:

 

a) Unitranche facilities: non-amortising loans upon which only interest is paid during the term, before a final bullet payment.

 

b) Mezzanine facilities: unsecured debt which commands a significantly higher rate of return than senior debt and often carries warrants to subscribe for ordinary shares.

4. Vendor rollover/deferred consideration: an alternative source of finance is to utilise funds from the vendor. This could be achieved by simply deferring payment of a portion of the consideration, creating an interest accruing loan in the business, or by the vendor maintaining an equity stake going forward.

Process For Obtaining Finance

The raising of finance is a complex and time consuming process which needs to be considered carefully to obtain the best results. The key steps are as follows:

 

1. Selection of funders: based upon the funding requirement, selecting a group of funders which will provide the optimum capital structure is vital. A list of appropriate parties to approach should be prepared in conjunction with advisors. 

 

2. Sharing of business plan: once NDAs are in place, sharing the business plan with funders will allow them to assess the opportunity in more detail.

 

3. Initial offers: these should include details such as the funding quantum, equity split, structure of investment (ordinary shares vs loan notes), fees, board constitution, good leaver/bad leaver provisions and diligence requirements. Offers should be reviewed and a shortlist of preferred funders progressed to the next stage.

4. Management presentation: once a shortlist of parties has been agreed, management will meet them in person in order to present their business plan and answer any questions from the funders.

5. Site tours: alongside the management presentations, it is also common for funders to visit the operational sites of the business at this stage. This can be done using a "cover story" in order to protect the confidentiality of the process and avoid it leaking to employees.

6. Final offers: the shortlisted funders should be asked to submit their best and final offer, following which the management team select their preferred partners.

Due Diligence

Diligence is a time intensive process, analysing all key aspects of the business

The due diligence process provides the opportunity for management and their funding partners to ensure that the historic operations of the business and the forward looking business plan are in line with expectations. 

Key workstreams include the following:

Financial & Tax: review of the historical financial performance of the business in addition to the assumptions underpinning the forecasts.

Commercial: research of the products, and customers of the business and the markets in which it operates.

 

Legal: a detailed review of all key legal areas including corporate documents, customer and supplier contracts, property and HR.

Environmental: an inspection of the sites at which the business operates to check for environmental issues, in addition to a review of internal policies and procedures.

Management: a number of private equity houses will require an external consultant to assess the strengths and weaknesses of the management team, in addition to performing a health check.

Legal Process

The legal process for a management buy-out is complex, requiring a number of different documents to be negotiated

Once the due diligence process has commenced, work will begin on the key legal steps to complete the transaction. MBOs require a a range of different documents depending upon the funding structure, but these typically include the following:

1. Sale and Purchase Agreement ("SPA"): the legal document governing the key terms of the company acquisition, including price, completion mechanism, warranties & indemnities and restrictive covenants.

2. Investment Agreement and Articles of Association for Newco: these documents set out the equity structure of the company post-completion of the transaction and the general terms of investment, including managerial and operational controls the investor will require in order to sufficiently manage the investment.

3. Banking Documentation: facility agreement and (where applicable) an intercreditor agreement to govern the terms of debt funding. The facility agreement will contain a range of financial covenants which will be monitored on an ongoing basis by the debt provider.

4. Service Agreements: terms and conditions as well as employment contracts for the management team.

Completion

Management buy-outs often include complex funds flows at completion

Upon agreement of the SPA and other legal documents, signing can take place.

 

The final step is to ensure that all parties receive the relevant funds. Preparation of a detailed funds flow is therefore a key step in ensuring that completion goes smoothly.

This will involve ensuring that all relevant funds are in place for the purchaser (including management's investment, private equity funds and bank debt) and that these are then safely transferred to the seller and any other relevant parties (such as the repayment of existing bank loans).

In order to simplify this process, funds are usually held in the legal advisor's client accounts and transferred from there in order to avoid any costly errors.

In an MBO situation, funds flows are often highly complex and the use of an experienced corporate finance advisor is highly beneficial.

DISCLAIMER: This page and the broader "Guide to a Management Buy-out" have been prepared only as a guide. No responsibility can be accepted by Eclipse Corporate Finance Limited for loss occasioned to any person acting or refraining from acting as a result of any material in this guide.

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