Management Buyout – An Alternative to M&A
The outbreak of COVID-19 had a profound impact on economies worldwide, including in Singapore where business owners had to take stock of their internal affairs amidst nationwide quarantine measures. Many investors were forced to halt their business activities or pursue M&A deals at significantly reduced rates.
Despite the challenges posed by COVID-19, business owners in Singapore are striving to adapt to the new normal and wait for the economy to stabilize before resuming normal operations. However, relying solely on this approach may not be sustainable in the long term.
When a business transition cannot be postponed, it is a good time to think about alternative arrangements – the most popular is the Management Buyout (MBO) arrangement.
What is MBO?
A management buyout (MBO) is a transaction where a company’s management team purchases the assets and operations of the business they manage, often with the support of external financing sources. In an MBO, the management team takes on the ownership of the company, typically with the goal of improving its performance or taking it in a new direction. MBOs are commonly used as a succession plan for retiring owners or as a means of restructuring the ownership and management of a company.
During a management buyout transaction, the present – or new – management team acquires ownership interest in the business. The benefits of a management buyout usually entail:
- 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
By leveraging the benefits mentioned above, business owners and shareholders can attain their financial and non-financial objectives. Despite this, the MBO succession option is frequently disregarded due to certain preconceptions, and as a result, not given due consideration. Some preconceptions include:
- The management 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, management buyout can be carried out in an organised manner, and produce great results.
The Following Steps Should Be Taken For Evaluating A Management Buyout:
- 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.
- 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
An independent consultant or advisor usually provides support during this stage, substantiating both the enterprise value and equity value of the business. The enterprise value represents the underlying value of the business, taking into account actual market transactions, business risks, and expected cash flow.
The equity value, on the other hand, is determined by adjusting the enterprise value for redundant assets, existing debts, and a reasonable amount of working capital. This is when all stakeholders collaborate to arrive at an acceptable pricing range based on current 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.
- 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.
- Closing the Deal
Achieving success in closing an MBO deal requires a significant amount of work from all parties involved, including financial advisors, lawyers, tax advisors, bankers, and shareholders. It is important for everyone to work together to ensure that the final arrangements are based on the agreed business terms.
Despite the challenges involved in the MBO process, a successful transaction can be very rewarding. In Canada, many successful businesses are owned by their staff. While an MBO arrangement may present some obstacles, it can often make sense in certain cases. Seeking the advice of a financial consultant or in-house consulting team can provide a better understanding of the matter.
If existing business owners and/or shareholders are willing to forego short-term benefits such as continued earnings, opportunities for immediate cash, and another payday down the road, and instead divest a portion of their equity for a more structured governance model, then an MBO arrangement may be the next logical step.
Speak with a certified management accountant today.
