Management buyout

What it means

An MBO, or management buyout, is the purchase of a company or part of it by its own managers. People who know the business from the inside and run its day-to-day operations become its owners. The purchase is usually financed by a mix of personal savings, a bank loan and sometimes a financial investor.

An MBO is a common succession solution when the founder retires and there is no successor in the family, or the successor is not interested. For the seller it means selling to people they trust, who will preserve the culture, the staff and customer relationships.

Since managers rarely have enough money of their own, the deal is often structured as an LBO: a new company takes the loan and repays it from the acquired firm's cash flow. When outside managers rather than the current ones buy the business, it is called a management buy-in.

How it works in practice

Preparation begins with succession planning years in advance. The owner gradually hands decision-making to the managers, the company learns to function without them, and the bank and customers get used to the new leadership. The less the business depends on its owner, the easier it is to finance.

The key issue is the price and the business valuation. Buying managers have more information than anyone else, which creates a conflict of interest: they may benefit if the company looks worse before the sale. An independent valuation and a transparent process protect both sides.

The gap between the asking price and what managers can finance is often bridged with deferred consideration, vendor finance or an earn-out. Legally and for tax purposes, a choice must be made between buying shares and buying the business, compared under share deal and asset deal.

What to watch out for

If the seller provides vendor finance, they remain tied to the company's fortunes after the sale and may not receive the rest of the price if problems arise. Security, a repayment schedule and rights in case of default, such as a pledge over the shares or a guarantee, should therefore be agreed.

The managers become entrepreneurs carrying personal risk. They often guarantee the loan with their own assets, and the company carries debt, so a fall in sales hits them harder than before. Before deciding, they should prepare a realistic repayment plan and take advice from financial and legal advisers.