Management and Sponsored Buyouts

Management and Sponsored Buyouts

In financial circles, a management buyout (MBO) is defined as a transaction wherein a company’s management team purchases the assets and operations of the business they manage. In mid-sized and small businesses, MBOs are common exit strategies for corporations who wish to pursue the sale of divisions that are not part of their core business, or for private businesses where the owners wish to retire. In such a scenario, a transfer to management can be the best way for an owner to sell. It can also be the best way for a management team to invest in the future growth of the company.

Financing a management buyout

Typically, an MBO is funded by private equity investors and structured either as an Equity Sponsored Buyout (ESB) or as a Leveraged Buyout (LBO).

  • Equity-sponsored buyout (ESB): Equity-sponsored buyouts typically consist of 2%-10% management equity, 40%-50% private equity capital and 40%-60% bank or asset-based lending. This leaves the majority equity ownership to be taken up by the private equity sponsor, with debt funding for about half of the proceeds to the seller. Sometimes, equity sponsors may also require up to 10% in a Seller note. This type of buyout is the most common and is sometimes referred to as ‘Sponsored Leveraged Buyout’, where the equity player is the “Sponsor”. The management mostly contributes a token investment of equity with the right to earn additional equity interest based on company performance. It may also secure rights to acquire further equity pari-passu to the equity sponsor’s contribution.
  • Leveraged buyout (LBO): A LBO would typically consist of 5%-15% management equity, 10%-25% seller note, 5%-20% mezzanine capital and 40%-60% bank or asset-based lending, making it a combination of seller debt, mezzanine debt and bank debt that funds the acquisition. Mezzanine capital plays a vital role in funding a leveraged buyout because of its lower cost when compared to equity and its less stringent structure when compared to senior debt. The advantage of a leveraged buy-out in an MBO is that it allows the management to gain enough funds without putting up a lot of their own capital.

Requirements for a successful management buyout

While considering a management buyout is it wise to consider the characteristics that would typically favour a successful MBO.

  • The business is an established industry.
    Mature industries that require low levels of capital investment and have a loyal customer base can contribute to a successful MBO. Typically, non-cyclical businesses with reasonable to high margins are the favoured choice.
  • The business should have a strong management team.
    In a MBO, investors back a management team above everything else. Previous experience, a proven track record and credibility is paramount. Furthermore, the management should be able to raise their own funds or pledge assets.
  • The business should have predictable and stable cash flows.
    Stable cash flows with profit margins above industry averages are warranted in a management buyout. Furthermore, financial reporting should be process driven, clear and efficient.