What Is a Management Buyout (MBO)? Definition, Reasons, and Examples

What Is a Management Buyout (MBO)?

The term management buyout (MBO) refers to a financial transaction in which a person or a group of managers in a company purchases the business from its owner. The managing members who execute the MBO acquire all the elements associated with the business. This type of acquisition is appealing to professional managers because of the greater potential for reward and control that comes with being a business owner rather than just an employee. An MBO is a type of leveraged buyout (LBO), which is an acquisition that is primarily financed with borrowed capital.

Key Points

• A management buyout is a transaction in which a company's management team purchases the assets and operations of the business they manage.
• MBOs often occur to take companies private in order to streamline operations and improve profitability.
• A management team pools resources to acquire all or part of the business they manage.
• An MBO is financed with a combination of personal resources, private equity sponsors, and seller financing.
• A management buyout is the opposite of a management buy-in (MBI), where an outside management team acquires the company and replaces the existing management team.

How a Management Buyout (MBO) Works

As noted above, a management buyout occurs when a company's manager or a group of managers purchases the business they manage from its owner. The business is acquired from a private owner and/or any shareholders in the company. The acquisition includes all the elements associated with the business, including its assets and liabilities. MBOs often take place because management feels they are better able to help the company grow and be financially successful. These transactions are important exit strategies for:

• Large corporations that want to sell off unprofitable or no-longer-relevant assets.
• Privately-owned businesses whose owners wish to retire.

The financing needed for an MBO is often substantial and is usually a combination of debt and equity that is sourced from the buyers, sponsors, and sometimes the sellers. Because it uses a large amount of borrowed capital, it is considered an LBO. It may therefore also be called a leveraged management buyout.

While management gets the reward of ownership after an MBO, they must make the switch from being an employee to an owner, which comes with significantly more responsibility and a greater potential for loss.

Why MBOs are Necessary

Management buyouts are risky ventures. Since they may or may not be successful. So why would a company's management consider executing an MBO? Here are some of the key reasons why a company's management may consider an MBO:

• Gain control: Members of management may disagree with the company's direction. By executing an MBO, they may feel that they have more control over the business, its success, and its future.
• Financial gain: Members of the management team may feel that they are not getting the full financial benefits of merely managing the company. By purchasing the company, they can benefit from it.
• They have the expertise: Management may feel that the owners don't have the knowledge or ability to lead the company. The company's 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.

The Approach to a Management Buyout

A successful MBO requires a great deal of planning and preparation. As such, it should never be rushed. Here are some of the elements that should be considered during the process:

• Pre-MBO considerations Any type of financial transaction should be well-researched. As such, management should come up with a fully thought-out and planned proposal or plan. Some points to include are:
• • The members of the management team involved in the MBO
  • The reasons for the acquisition
  • The intent and goals after completion
  • The terms of the deal, including the purchase price
  • How the acquisition will be financed It's always a good idea for management to show the company owners that they've done their homework. This includes performing a thorough valuation analysis and conducting proper due diligence. Although the current managers work at the company, there may be hidden issues, like outstanding lawsuits, that they are not aware of.
• Financing A substantial amount of money is needed for an MBO due to their large size. There are a number of different sources management can use to secure capital for the deal:
• • Debt: Management often turns to banks and other lenders to secure financing. Banks often view MBOs as fairly risky ventures, so they may not finance a portion or all of management's request. This means buyers may have to look to a primary source of financing elsewhere before they turn to a lender to cover any shortfalls.
  • Private equity: Private equity firms are often receptive to financing MBOs if the banks say no. One thing to note is that these firms often expect to receive a portion of the company even though they are just lending management money.
  • Other types: There are a number of other types of financing management uses, including financing from the owner, which is financed directly from the seller to be repaid, or mezzanine financing, which involves a combination of debt and equity.
  • Personal financing: Managers can use their personal finances, like savings to purchase the company. This usually happens when the individual managers are very wealthy or have access to capital. Management should conduct a thorough due diligence while considering an MBO. This includes a full review of the company and its financial and legal framework.

Pros and Cons of an MBO

Pros Management buyouts are viewed as good investment opportunities by investment funds and large sponsors, who often encourage the company to go private so it can streamline operations and improve profitability out of the public eye. They are encouraged to go public at a much higher valuation in the future. A private equity fund that backs an MBO will likely offer an attractive price for the asset, provided there's a dedicated management team.

Cons There are a number of disadvantages to an MBO structure. While the management team may get the rewards of ownership, they must make the switch from being an employee to an owner, which requires a change from a managerial mindset to an entrepreneurial one. Not all managers can successfully make this transition. The seller may also not get the best price for the sale of the asset in an MBO. The managers may have a conflict of interest if the existing management team is serious about bidding on the asset or operation being sold. Simply put, they may undervalue or deliberately sabotage the future prospects of the assets being sold in order to purchase them at a relatively low price.

Management Buyout (MBO) vs. Management Buy-in (MBI)

The opposite of an MBO is a management buy-in (MBI). While an MBO involves the company’s internal management purchasing the operations, an MBI occurs when an outside management team acquires the company and replaces the existing management team. MBIs usually involve companies that are run by poor management teams or are undervalued.

The advantage of an MBO over an MBI is that since the current managers are acquiring the business, they have a better understanding of the business and don’t have to go through a learning process as they would if the business were being run by a new management team. MBOs are performed by management teams that want to receive the financial rewards for a company’s future growth more directly than they would as just employees.

While private equity funds may get involved in MBOs, they often prefer MBIs, where the companies are run by managers they know instead of the existing management team.

Example of an MBO

A classic example of a management buyout is 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 have more control over the company's direction. The company returned to public status in December 2018. Shares trade on the New York Stock Exchange (NYSE) under the ticker symbol DELL.

How does a management buyout work? A management buyout works when one or more members of a company's management team want to purchase the operations from the owners. The goal is to take the company private so it can continue to grow. These acquisitions are usually financed 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 buy the computer/technology company he founded from shareholders. He took Dell private before the company returned to public status in 2018.

How do you finance a management buyout? There are many ways to finance a management buyout. Debt financing involves borrowing from banks and other lenders. However, banks may not consider financing these types of transactions due to the risks involved. Private equity firms are often more inclined to finance MBO deals. Some may require a portion of the company’s stock in addition to being repaid. Buyers may also approach the owners/sellers for a loan or use a combination of debt and equity to pay for the acquisition.

Conclusion

Mergers and acquisitions are an important part of the corporate world. It is not uncommon to hear about takeovers, vertical mergers, and management buyouts. MBOs involve a business's management making an offer to purchase all or a portion of the business they manage. The goal is to take it private so it can continue to grow. While MBOs happen in large corporations, they are also quite common in the small business world—often when a company is transitioning from one generation to the next.