There are times when the best option for a smooth deal process and easy exit for a business owner is a sale to the company’s management team. But there can be some disadvantages, including lower valuations where the management team takes on a heavy debt burden to execute the deal.
“The management buyout (MBO) investment structure presents an attractive exit strategy for business owners under specific conditions and has become a well-established component of the Irish M&A landscape,” says BDO corporate finance director Richard Duffy. “When structured effectively, an MBO can create mutual value for all stakeholders, as evidenced by notable success stories in recent years.”
According to PwC Ireland corporate finance partner Laura Gilbride, an MBO is particularly suited to Irish SMEs where owners are looking for a succession plan that ensures business continuity.
“It’s often ideal when there is a well-established management team with deep sector knowledge and strong local relationships,” she says. “Globally, MBOs are also common in industries where maintaining the existing operational model is critical, such as professional services or niche manufacturing. In Ireland the MBO option is attractive for family businesses seeking a smooth transition while preserving legacy and protecting local jobs.”
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Management buyouts often pose an attractive exit option where a mature or maturing business has been run by a capable management team for a period of time before a deal is proposed, says Mark Queally, a partner with the William Fry Corporate/M&A department.
“Often, the catalyst for an MBO proposal will be the fact that the business’s management team sees strong potential for growth if investment is made in the business, but the seller lacks, for whatever reason, either the appetite or the capacity to make what management see as necessary investment,” he explains.
“This may occur, for example, in a family-owned business where the owners do not have the financial capacity to back the management team’s plans any further; or in a subsidiary or division within a wider corporate group which has been dubbed ‘non-core’ to that wider group’s strategic goals.
“The opportunity for the management team to acquire the business and bring in the necessary external investment to pursue their vision for the business’s increased potential, while also providing an exit pathway for the existing owner, can be an attractive proposition for all stakeholders.”
Continuity is one of the key advantages of an MBO deal, according to Gilbride. She says this is particularly important in the Irish context where smaller businesses often rely on personal relationships.
“It ensures the business stays in familiar hands and is led by a team with a vested interest in its success. On a global level, MBOs also minimise disruption by retaining institutional knowledge, which can be critical in sectors such as healthcare or education.”
From a seller’s perspective, the principal advantage of selling a business to its existing management team is that they will already be highly familiar with the business, Queally points out.
“This often means that the buyer’s due diligence exercise can be reduced in scope and duration, and the transaction documents less heavily negotiated. Because the buyer already has a degree of familiarity and comfort with the business, it will be less worried about seeking very extensive protections in the deal documents against unknown or unquantifiable risks.”
Changes to funding structures in recent years have made the MBO option even more attractive.
“MBO teams traditionally tapped funding from banks, as debt finance dominated their thinking as it allowed incoming management teams to have full ownership of a business,” says Duffy.
“However, these has been a paradigm shift in the Irish market regarding the benefits of using private equity (PE) over traditional debt-focused financing for management-backed deals.
“This has led to a significant increase in the number of business owners selling to private-equity-backed buyout teams. This has negated the need for management teams to be overburdened by significant leverage on deals and helps them find a more efficient capital structure which can balance the risks and rewards of an MBO.”
Despite this the seller may still get less value than they would in a trade sale, says Duffy. However, in the event of a trade sale they are probably going to have to use some of the proceeds to incentivise the management to stay on post transaction.
“Overall, we still find the biggest hurdle in management-backed deals is the price expectations of incumbent owners of companies potentially over-valuing their businesses,” he adds.
There are risks to MBO deals, however, but there are ways of mitigating them.
“If a business owner receives an MBO proposal from its management team, we would always advise them to seek an understanding of how the MBO team propose to fund the transaction, as this can give rise to deal-certainty considerations,” says Queally.
“For example, if the MBO team will be backed by a PE fund which already has material existing investments in Ireland, this may increase the likelihood that the deal will require mergers clearance or other regulatory approval, particularly if the PE’s existing investments are in the same or adjacent industry sectors.”
A common tool utilised in M&A transactions to mitigate risk for sellers is to require the buyer to obtain warranty and indemnity (W&I) insurance cover in respect of the deal, he adds.
“This essentially means that the transaction documents will contain customary warranties and protections for the buyer or MBO team, but that any claim under those terms will be underwritten by an insurance company, rather than by the seller. This arrangement de-risks the exit transaction for the seller, while still providing appropriate protection for the MBO team and any financial backers of the MBO.”
