Key Success Factors for a Management Buy-out
In a management buy-out (MBO) transaction the owner sells its company to the existing managers (the “MBO-team”) and their co-investor. An MBO can represent a valid option for (family) business owners to realize a succession solution (or for corporates to carve-out a business unit). It provides certain important advantages compared to an alternative sale to a strategic buyer, such as retaining the independence of the firm, limited disruption of business and less dependence on M&A market cycles. However, it typically also involves specific challenges. What are the issues and the key success factors for business owners and the MBO-team to get to a successful MBO transaction? This article addresses the main challenges and how they can be overcome.
We would like to focus on the four key success factors we consider most important. We have split them into manageable phases as described below. While the numbers indicate the recommended sequence, the phases are interdependent and sometimes run in parallel:*
1. Aligned MBO-team
Combining a strong and integrated team of managers that is willing to take over ownership is the cornerstone of a successful MBO transaction and operation of the firm afterwards. Ideally, the MBO-team has:
- strong entrepreneurial spirit and a good balance of functional /managerial expertise, as well as
- strong partnership spirit / “chemistry” between the team members.
The process of creating such a team is sometimes underestimated and especially the second element tends to get more complicated with the number of managers involved and with potential divergences in participating managers’ relevance within management and investor team. The transformation from managers into future owners involves a change of perspective and strong personal commitment. This typically requires a further increased cohesion within the MBO team.
We recommend to invest sufficient time to clarify each MBO-team member’s a) vision for the firm, b) personal risk attitude, investment horizon and investment amount (and related ownership stake) and c) expected cooperation style with the co-investor. Agreement on these factors is important, also in order to select the right co-investor and to get to a successful deal with the existing owner.
2. Solid mid-term strategic plan by MBO-team
While the MBO-team has a deep operational understanding of the firm, a thoroughly worked-out strategy and mid-term business plan is not always in place. These elements are relevant to define the firm’s strategic, operational and financial challenges and opportunities and to get to a common assessment of the attractiveness of the investment. Especially in strategic and/or financial turnaround situations it is important to work out a value-enhancing strategy and business plan to define possibly required cash injections into the firm (in addition to the purchase price for the seller).
We recommend that following the establishment of the MBO-team, the strategy and business plan is approached as next step. Depending on the circumstances, it can be beneficial to involve the owner in this phase to achieve a common understanding of the firm’s strategic and financial situation as basis for the agreement on the adequate value for the firm between both sides.
3. Selection of right co-investor
The seller’s price expectation, the business plan for the firm and the MBO-team’s collective investment amount, risk attitude and expected ownership stake drive the required co-investment amount (majority/minority) and the financing structure (equity/mezzanine/debt). Different investor types follow different investment philosophies. The list of investors to be approached needs to be carefully determined and can include private equity players, family offices, private/entrepreneurial investors and sometimes dedicated vehicles of banks. A good match in the partnering philosophy is a key factor from the MBO-team’s perspective.
We recommend to test fit on technical and soft factors early on in the interaction with the co-investor. This should also include discussing the key elements of corporate governance and the collaboration style and intensity. Agreement on these elements also facilitates a coordinated approach to the final agreement with the seller and reduces the risk of failure in the negotiation of the sale & purchase agreement (and of the shareholders’ agreement between MBO-team and co-investor).
4. Successful agreement between seller and buyer
As in any M&A transaction there are typically diverging positions, specifically on price, between seller and MBO-team/co-investor. However, the specific relationship can also ease the path to a deal. The fact that a management-driven buyout provides a higher trust level to the seller and more continuity to his firm - often his lifework - can facilitate the transaction structuring including options such as seller loan or earn-out arrangements. On its side, the MBO-team who knows the business well can accept significantly reduced due diligence and guarantees by the seller (at least in an MBO set-up where management has a strong role vis-à-vis its co-investor).
We recommend to leverage on the above positive elements to get to a successful outcome of the negotiations. This includes to use the management as trust-building link between seller and co-investor, especially if the seller has already been involved in the strategy and business plan phase. Ideally, the additional time invested in the preparatory steps (see above) pays off with a shortened negotiation phase and high success rate for closing the MBO transaction.
Based on our achievements as entrepreneurial investor, working in close partnership with managements, and as M&A advisor experienced in MBO transactions, we can add significant value to each of the above steps and the overall success of an MBO transaction. In a recent transaction for Peter Lang AG (June 2015), we advised both seller and management in an honest broker role, leading to a successful sale of the firm to a committed and entrepreneurial MBO-team. Do you plan an MBO transaction? We would be happy to discuss with you!
* The article is referring to an MBO transaction process characterized by a bilateral situation between seller/management; a process controlled by the seller and including other parties (strategic or external buy-in managers) would involve additional success aspects.