Who is the right buyer for your business? It can be helpful to categorize the various buyers into four primary categories when communicating with business owners. In our first of this series, we will outline some of the primary advantages and drawbacks of a management buyout.
Before initiating the sale process, it’s important to understand that various buyer types exist. Every buyer is different, but for purposes of this blog series, we have categorized them into four main types: management buyout, financial buyer, strategic buyer, and employee stock ownership plan (ESOP). Today, we will focus on a management buyout. A management buyout, or MBO, involves selling your business to current members of the management team. This is a common strategy that presents unique advantages and drawbacks, as outlined below.
Key advantages of an MBO include:
- Continuity: Due to existing management’s knowledge of the business, the ownership transition is often smoother than if the company were selling to an outside party, provides for management continuity, and preserves company culture.
- Retention: An MBO can aid in retaining employees, particularly employees that are crucial to the success of the business.
- Alignment of Interests: An MBO often leads to increased commitment from the management team due to an alignment of interests.
- Flexibility: The seller can retain a minority interest or sell the business in its entirety.
- Company Size: Outside buyers typically have target size criteria. An MBO can be a good option for businesses that are too small to attract an outside buyer.
- Confidentiality: Negotiations with an inside buyer means confidential information remains inside the business.
Key drawbacks of an MBO include:
- Price: The price paid for a business in an MBO is typically lower than what could be offered in a sale to a third party because the management team is not gaining any synergies that may be available to an outside buyer.
- Financing: The management team may lack the personal wealth or liquidity to finance the transaction, and obtaining outside financing can be challenging. Alternatively, the seller can choose to finance the transaction through a loan to the management team. However, if the business doesn’t perform as expected or members of the management team experience financial challenges of their own, it can result in financial strain on the management team and/or a longer repayment period for the seller. While the management team may be able to raise outside capital, this often comes with other risks and consequences that may not align with the seller’s goals.
- Relationships: If the seller and management team can’t come to an agreement, or if certain individuals are excluded from the offer, this could impact their personal relationships and the business going forward. Also, depending on how many buyers participate in an MBO, issues around control, leadership, and consensus building may become hinderances, both, during and after the transaction.
- Tax Impact: Depending on how the transaction is structured, the buyer (s) in an MBO may wind up having to finance the transaction with after-tax dollars, putting additional strain on their ability to repay any loans, or pay a price acceptable to the seller.
If you’re considering an MBO, it’s important to carefully evaluate these (and other) advantages and disadvantages. While often a viable option, we encourage you to understand how an MBO differs from other alternatives. In our next post, we will highlight the pros and cons of selling to a financial buyer.
For other related content now, check out the prior post in this series!