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Management buyouts: Assessing the viability of this exit strategy for your recruitment business

In this insight we delve into the intricacies of MBOs, exploring their definition, mechanics and, most importantly, weighing the pros and cons associated with this particular exit option.

Management buyout defined

A management buyout (MBO) occurs when the existing management team of a company purchases the business from the current owner(s). This option allows the management team to take control and become the new owners of the business. MBOs can offer a sense of continuity, as the management team is already familiar with the operations, culture, and potential growth opportunities.

How do management buyouts work?

Below are the essential stages that shape the process of an MBO:

Management team formation

The first step in an MBO is the formation of a capable management team that possesses the necessary skills, experience, and expertise to lead the business forward. This team should include individuals who are committed to the success of the MBO and have a clear vision for the future of the company.

Valuation and financing

The next crucial aspect is determining the value of the business. Valuation can be a complex process, considering factors such as the company’s financial performance, growth prospects, market position, and industry trends. As a starting point check out our online business valuation calculator. Once the valuation is established, the management team needs to secure the necessary financing to fund the acquisition. This may involve a combination of personal investment, bank loans, and external financing sources.

Negotiating the deal

Negotiating the terms of the MBO is a critical stage. This involves discussions on the purchase price, payment structure, ownership shares, and any conditions or contingencies associated with the acquisition. The negotiation process requires careful consideration of the interests of both the selling owner and the management team, aiming to strike a fair and mutually beneficial agreement.

Due diligence

Similar to other types of business acquisitions, due diligence is essential in an MBO. The management team conducts a thorough review of the business’s financial records, contracts, client relationships, and other critical aspects to ensure transparency and assess potential risks. This step helps the management team make informed decisions and validate the value of the business before proceeding with the transaction.
Financing and Legal Arrangements: Once the due diligence phase is complete, the management team secures the necessary financing to fund the acquisition. Legal agreements, such as purchase agreements and shareholder agreements, are drafted and executed to formalise the transaction and establish the new ownership structure.

Transition and business continuity

After the acquisition, the management team assumes control of the business and focuses on executing their strategic vision. It’s crucial to ensure a smooth transition and maintain business continuity during this phase, including retaining key employees, nurturing client relationships, and implementing any necessary operational changes.

Timeframe for an MBO

The duration of completing all the stages involved in an MBO can vary depending on various factors, including the complexity of the transaction, the size of the business, and the parties involved. While the stages of an MBO may take several months to complete, it’s important to note that building a trusted management team can take years. By considering this exit strategy at the earliest opportunity, you can proactively shape and strengthen your management team while providing a compelling incentive for them to remain committed to the business, driven by the enticing prospect of becoming owners themselves.

Deal structure

The structure of an MBO typically involves the management team acquiring a controlling stake in the business from the existing owners. This can be achieved through various mechanisms, such as purchasing shares directly from the owners, issuing new shares to the management team, or a combination of both.

The most common deal structure for a management buyout (MBO) entails the management team establishing a holding company to acquire a controlling stake in the business from the existing owners. This approach is preferred because it enables the owners to finance the deal. For example, if the company is valued at £1 million, the holding company acquires all the shares, and the owner provides a loan of £1 million to the holding company. Over a specified period, this loan is then repaid using the company’s profits. This financing method is often regarded as a cost-effective way to secure the required funds for the MBO.

EMI Scheme

An Enterprise Management Incentive (EMI) scheme can play a crucial part in incentivising and rewarding key employees. An EMI scheme allows eligible employees to acquire shares in the company in the future at a pre-determined price, aligning their interests with the company’s long-term success. If you’re interested in learning more about EMI schemes, be sure to check out our comprehensive guide on Long Term Incentive Plans.

In the context of an MBO, an existing EMI scheme can be particularly advantageous for employees. If the MBO qualifies as a triggering event and the employees are involved in the MBO, they will have the opportunity to acquire a portion of their shareholding through the EMI scheme at the agreed exercise price.

Why is an MBO such an appealing exit strategy?

Opportunity for senior management: An MBO presents a significant opportunity for the senior management team of your business. By acquiring a controlling stake in the business, they not only improve their potential future earnings and wealth considerably but are also given the opportunity to guide the business to further long-term success.

No need to market the business for sale: Unlike selling a business to a trade buyer, an MBO eliminates the need to market your business extensively to source a suitable third-party buyer.

Full market value of shares (generally): In an MBO, the exiting owner generally receives the full market value for their shares, subject to negotiation. This ensures that the exiting owner receives a fair price for their stake in the business.

Fewer potential issues (certainty of exit): With an MBO, there is a higher chance of completing the transaction without complications or disruptions. Selling to people within your company minimises the challenges associated with finding an appropriate buyer and dealing with legal challenges that can delay a trade sale.

Preserve the legacy of your business: A Management Buyout raises fewer questions about the long-term future of your business. By putting the incumbent senior management team in the position of ownership, an MBO ensures continuity and preserves the legacy of your business.

Performance and management continuity: The senior management team’s strong understanding of your business, its history, candidate and client base, performance, culture, and the team contributes to a smoother transition. Transferring ownership to those who are already running the business day-to-day ensures management continuity and facilitates efficient decision-making.

Drawbacks of MBOs

The business will usually take on debt: As an MBO is typically funded through a combination of borrowing and deferred consideration, the business takes on debt. This debt must be considered by the management team and can affect the cash flow and financial health of the business during the repayment period.

Price may be lower than in a trade sale: While the exiting owner generally receives the full market value of shares in an MBO, the price may be lower compared to what a strategic trade buyer may offer. This trade-off should be carefully considered in light of other advantages and the long-term potential of the business.

Managing the current owner’s departure: Striking the right balance between allowing the new owners to take control and ensuring a smooth transition can be challenging, especially if the current owner maintains an equity stake. Clear terms and effective communication are crucial to managing the departure and preserving vital company information and relationships.

In summary

MBOs provide an opportunity for recruitment business owners to transfer ownership to their trusted management team. With continuity, shared vision, and potential financial benefits, MBOs can be an attractive exit option. However, it’s important to consider financing challenges, valuation negotiations, and the transition of ownership and responsibility to the new owners.

The next step

This article is provided by Recruitment Accountants, a division of UHY Hacker Young. If you own a recruitment business and would like to discuss exit options, call their team of experts on 0845 606 9632 or email hello@recruitmentaccountants.com.

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