What is a Management Buyout (MBO)?

From Your Multimillion-Dollar Exit, by Wayne Zell

As an alternative to an M&A transaction with a strategic buyer, PE firm, or family office, you could try to sell your business to your management team.

But...What IS a Management Buyout (MBO)?

MBOs are often the most difficult transactions to negotiate and close. The results depend heavily on the availability of capital to the management team/buyers. If the management team is properly motivated to acquire your business, they should engage separate counsel and separate advisors to help them structure a deal that will allow them to acquire your ownership interest. You should be represented by separate counsel and advisors as well. Because your interest is adverse to the managers, negotiations can be quite complex and tricky. Ideally, each of you should pay for your own expenses.

What are the advantages of a management buyout?

They know the business, suppliers, vendors, and clients/customers.
They may also have creative thoughts on how to grow the business in your absence.
If they have “skin in the game” in the form of their own invested capital, they’ll be more motivated to keep the business profitable.
You could retain a minority stake in the business as well, yielding full responsibility for running the company to the managers and keeping open access to the financial performance and plans of the company.

What are the disadvantages of a management buyout?

Managers may lack sufficient capital to purchase the business, indicating the need for seller financing or no deal at all.
Managers may lack your force of personality, which could jeopardize prospects for the company, particularly if your charisma fueled the growth and success of the business.

If your situation is dire, but you are confident in your management team, you may be willing to let the managers borrow from you to pay the purchase price in the hope that they generate enough cash to pay you for the value of your business. Savvy sellers will want to retain certain protections against default by the managers. This might include keeping a security interest in the stock or membership interests that you’re selling to the managers or including a security interest in the overall assets of the business. In addition, you may insist on the managers and their spouses personally guaranteeing the debt used to purchase your interest.

What are the risks of selling to your managers?

As noted, you can take back seller financing, where you receive a promissory note from each of the managers who are buying your ownership interest or the company or both. The longer it takes to pay off the purchase price, the greater the risk to you as the seller.

To compensate for the increased risk, you may require:

A significant initial deposit
A higher interest rate in the notes
Greater security in the form of pledges of the ownership interests you are selling and company assets, as well as personal assets of the borrowers
Personal guarantees of the managers and their spouses, so you can recover the benefit of your bargain.

Today, a business that generates excellent cash flow may enable managers to assemble the necessary third party financing to buy the business. The outside lenders, however, will require the managers to undertake significant risks in doing so, by forcing them to provide personal guarantees for the debt that is being provided to purchase the business. If private or commercial lending sources are not available, you may not be willing to finance all or any portion of the purchase price that the managers are paying you, simply because of the risk that they may not be able to pay the purchase price from the cash flow of the business.

BOTTOM LINE: You should not risk selling your business to your managers unless you are certain they will remain dedicated to its ongoing success and will be able to pay the purchase price you are seeking.