M&AOctober 21, 2020by Business Valuation TeamManagement Buy-Out: A M&A Alternative

COVID-19 happened and shook the economy everywhere, affecting the marketplace as business owners in Singapore stock-take their internal business affairs in view of the nationwide – and soon worldwide – quarantine. Investors had to temporarily stop their business activities or go for M&A deals at much discounted rates.

There was no telling how the COVID-19 crisis will play out – when the pandemic will end; when the damage to the economy will ease; and when things will return to normal. Hence there is a lot of uncertainty created in the business world, causing disruptions that in reality will greatly affect the marketplace.

Every business owner in Singapore strives with the limited opportunities presented by COVID-19, going with the flow of the new normal while waiting for the economy to stabilize, and things to return to normal. This may be the best response for the time being but it is not sustainable in the long run.

A Business In Singapore Cannot And Does Not Want To Postpone A Business Transition In The Following Cases:

  • When the business capital structure bears weaknesses in view of COVID-19;
  • When it is appropriate to hedge future business risks;
  • When family and/or health issues are at stake;
  • When there is readiness to explore available options and do a transition.

When a business transition cannot be postponed, it is a good time to think about alternative arrangements – the most popular is the Management Buy-Out (MBO) arrangement.

What is MBO?

During an MBO transaction, the present – or new – management team acquires ownership interest in the business.

This allows the following benefits:

  • Improves management engagement
  • Boosts management commitment
  • Enhances the business value through management continuity
  • Allows existing business owners and/or shareholders to take money off the table without retiring
  • Supports a smoother transition of ownership when the time comes

With the above benefits, existing business owners and/or shareholders can achieve their financial and non-financial goals.

However, due to the following preconceived notions, the succession option that comes with MBO is often neglected, and hence not considered:

  • The staff will not be able to raise the capital
  • The staff does not have the relevant skills and knowledge
  • The current owners and/or shareholders will be leaving money on the table

With due diligence – proper preparation and planning-, MBO can be carried out in an organised manner, and produce great results.

The Following Steps Should Be Taken For Evaluating An MBO:

  1. Making Discoveries

This discovery stage helps to envisage the business during post MBO so the MBO process would seem more worthy of the needed time and effort.

As an MBO arrangement usually requires heavy lifting to close a transaction, the business owners and/or shareholders must first be familiar with the various available options, and the pros and cons of each one.

  1. Analysing

Here, the road map to complete the transaction is laid out in terms of the financial, tax, operational and governance components of the MBO.

The analysis at this stage has many features; the main components are as follows:

  • Governance

This refers to the agreement and the set of policies dictating the future employee-shareholders post transaction – after the MBO process.

To reduce time wastage post transaction, it is always better to sort out issues related to governance early in the MBO process, especially when there is unwillingness to surrender certain control of the business to the governance system.

Hence A Good Governance System Should Consider And Explicitly Explained The Following Issues:

  • Difference in roles between the CEO and the shareholders
  • Type of decisions that require approval from shareholders
  • Type of decisions that require a unanimous approval from all the shareholders
  • The shareholder agreement
  • Daily responsibilities of a shareholder
  • The valuation of equity
  • The procedures and mechanism for the buying and selling of shares
  • Pricing Analysis

This is usually supported by an independent consultant or advisor, which substantiates the enterprise value and the equity value of the business.

The enterprise value refers to the business’s underlying value in view of the actual market transactions, business risks and expected cash flow.

The equity value is then the conclusion after adjusting the enterprise value with respect to the redundant assets, existing debts and a reasonable amount of working capital.

This stage is when all the stakeholders come together on an acceptable range of pricing based on the latest market conditions.

  • Financing Structure

Should existing staff be involved in the MBO, then usually there is limited outside cash available for investment. Working out a financing structure would then require creative means.

Fortunately, MBO transactions are generally seen as low risk by investors hence there are different capital sources to fund them.

  1. Offering

Though the MBO is a way of M&A, it is still different from a normal M&A process which has the business owners and/or shareholders divesting 100% of their shares.

With MBO, there are additional complications relating to financing and governance, such as allowing non-staff to become a new employee-shareholder. This is considering the fact that talents from other companies possess the abilities useful for business development and growth.

Hence this stage requires a neutral third-party consultant or advisor preparing the essential information – underlying supporting data – and materials of the offering for the candidates.

  1. Closing the Deal

There is no shortcut in closing a deal. There must be a significant amount of work done to achieve success, and everyone – the financial advisors, the lawyers, the tax advisors, the bankers and the shareholders must come together to make things work, and ensure that the final arrangements are based on the agreed business terms.

Though the process of MBO has its difficulties, a successful MBO transaction is worthy of the time and effort invested. There are many success stories in Canada where most of the successful businesses are owned by the staff.

An MBO arrangement may give a challenging path but it does make sense in many cases. It is good to seek better understanding of the matter from a financial consultant or an in-house consulting team.

When there is willingness amongst the existing business owners and/or shareholders to let go of the short-term benefits in continued earnings, opportunities for another payday down the road and immediate cash; and divest a part of their equity for a more structured governance model, then taking the MBO arrangement is the next step.

Speak with a certified management accountant today.