Selling a company to the existing management team can be the best option when it comes to speed of transaction and the potential for deal structure flexibility. But there are pitfalls too.
“A management buyout (MBO) is a very attractive option for a seller where there is a strong management team in place and a reluctance on the part of the seller to approach the open market,” says Mary Kiely, a partner in law firm Eversheds Sutherland.
“From the seller’s perspective, an MBO usually means a speedy transaction process involving little due diligence and more simplified transaction documentation containing limited warranties. In addition, management buy-outs typically make it easier to maintain confidentiality in respect of commercially sensitive information which may be a concern for sellers, depending on the business sector.
“However, there is often a valuation trade-off for such advantages. If, as a seller, achieving maximum valuation is your only priority, a management buyout may not be the right choice for you.”
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If the economics of the transaction do work, it is important to move fast and agree the key commercial terms of the transaction upfront, preferably in heads of terms.
“This will help set expectations of the parties at the outset and avoid any protracted negotiations,” says Kiely. “MBOs can be high risk. If the management team is key to the business and the MBO fails, relationships can be permanently damaged. Therefore, preparation and communication by the parties is key.”
From the management’s perspective, an MBO opportunity is, more often than not, a once-in-a-lifetime one.
“If funding is a concern, engage a corporate finance adviser early,” Kiely advises. “Pillar banks no longer have the monopoly on funding. In recent years, we have witnessed an influx of private equity (PE) investment in MBO deals, changing the landscape of traditional MBO funding. Private equity firms will be particularly appealing if the management team has ambitious growth plans.”
Last year was generally a quiet one for transactions but pent-up demand suggests that will change this year.
“There are a lot of private equity firms around with big cash resources that they are under pressure to invest,” says Paddy Quinlan, a partner with global law firm Taylor Wessing.
MBO teams traditionally tapped funding from banks. Debt finance dominated their thinking because it allowed incoming management teams to have full ownership of a business.
“However, with the benefit in recent years of a highly active local and international private equity market here in Ireland, the typical approach now is to see private equity involvement,” says Richard Duffy, director for deal advisory at BDO.
“Their funding forms the backbone of a deal, along with an appropriate level of debt finance, and management teams with equity participation – albeit a lower stake – highly incentivised to accelerate the growth plans they might have for a business.”
As such, there has been a significant increase in the number of Irish business owners selling to management buyout teams, says Duffy.
“Despite a decrease in deal volumes last year compared to the post-Covid period, management-backed deals remain the cornerstone for mid-market companies and their owners looking for an exit,” he adds.
MBOs have traditionally worked well for established, niche operating businesses that are highly cash generative, with a strong customer base and established markets.
“From a seller’s perspective you get certainty and an exit, particularly where there is no apparent successor to take over the reins in a family business situation,” says Duffy. “Many owners don’t necessarily want to sell to a trade player either and are keen to see their business continue as is. An MBO is an attractive option in such circumstances.”
Going to the trade can unnerve staff, customers and suppliers, potentially impacting adversely on the value of a business; the opportunity to do an off-market deal avoids this, Duffy points out.
“Confidentiality surrounding the sale can be much more easily maintained as well through an MBO process,” he says.
Given the higher interest rate environment, Duffy has seen a rise in the use of vendor loan notes and/or retained minority stakes in MBOs.
“In particular, the size of the vendor loan-note element and/or retained shareholding stake has increased for sellers. However, this is enabling management teams to complete a deal at sustainable debt levels while also locking in value for the seller going forward,” he points out.
“For those private-equity-backed deals, increasingly the approach adopted is for them to finance the deal themselves upfront in full and thereafter, once the deal is concluded, seek to replace a portion of their funding with debt when appropriate.
“As such, the deal is not contingent on securing debt finance, allowing the private-equity-backed management team to concentrate on negotiating terms with the seller and for themselves with the PE fund.”
There is still a role for debt funded MBOs, adds Mags Brennan, debt advisory partner at BDO, pointing out that bank debt is still the cheapest form of funding, even at today’s rates.
While there are now only three domestic banks – AIB, Bank of Ireland and PTSB – supporting the corporate lending market, compared with 10 just 15 years ago, there around 65 alternate debt providers, as well as some international banks which continue to operate in the corporate market.
“Some, such as Citi and JP Morgan, are looking at expanding their commercial lending business in Ireland,” says Brennan. “Funding is available but the offering across all providers is quite different both from a terms-and-conditions, and a pricing perspective.”
For the seller, there are particular MBO pitfalls to look out for.
“Different requirements of funding partners, such as a pillar bank, alternative lender or private equity backer, will each bring different requirements and may remove some of the key advantages of an MBO,” cautions Philip Lea, partner, corporate and commercial, at law firm Dillon Eustace.
“For example, a private equity backer will likely require a full due diligence completed, sellers are likely to find it harder to shift risk to the MBO team and the process may become more drawn out,” he says.
Issues can arise over valuations too. “If a seller does not have much involvement in the day-to-day operations of the company there is a risk that the MBO team could have been manipulating data or withholding information in advance of a sale to drive a lower valuation,” says Lea.
“In addition, if the MBO team is very important to the business they may seek to leverage their position in a business to present an MBO as the only option – that is, that the MBO team would refuse to support sale to a third party.”
If an MBO is ultimately unsuccessful then the performance of the business may be adversely affected, not least because both management and sellers have been distracted. That may make the company harder to market in the future.
Indeed, much of the downsides to an MBO result from the process becoming a dragged-out affair.
“To manage this risk a clear timetable should be established at the outset with agreed valuation and heads of terms,” says Lea. It will be key that the MBO team is kept to this timetable by deal management and periods of exclusivity.
“In addition, we would recommend that evidence of committed funding for the process be provided at an early stage of the process which is based upon a heads of terms setting out certain key terms.”
He adds: “With respect to potential devaluation tactics, some of these elements may be mitigated through deal structure – for example, by retaining a stake in the business, or by contractual clauses, such as anti-embarrassment clauses – which protect against flipping the business for a much higher valuation.”
