What is an MBO?
A management buyout (MBO) is a transaction in which the company’s management team purchases the
assets and operations of the business they manage. Typically, management teams enter into MBOs so
that a business can be carved-out in an effort to streamline operations, improve profitability, and
become a platform for future growth and value creation.
● Management is intimately familiar with the company and can continue to operate it without
fear of loss of business, customers, or quality of product.
● The management team is well aware of areas where streamlining, cost cutting, or
enhancements can be made to improve margins and profitability.
● Management, as new owners, are aligned and incentivized to use the existing business as a
platform for growth.
● The transition for management to ownership can be difficult and requires a sometimes dramatic
change in mindset.
● Managers will be required to contribute a portion of the necessary funds to finance the MBO
which may pose financial difficulties for some.
● If the seller is engaged in an M&A sales process to dispose of the business, the potential for a
conflict of interest exists. Existing managers may downplay future prospects of the business in
hopes of acquiring it at a relatively lower price.
Who funds an MBO?
In an MBO, a management team will pool resources to acquire the business they manage. Funding
usually comes from a mix of the management’s personal resources, debt financing, seller financing, and
Private Equity. Each MBO is different, as is the mix of funding.
Existing management is expected to provide a healthy amount of the funds necessary to acquire the
business. In addition to acquiring equity, the purpose of the funds is to align management incentives
with that of the business as well as provide confidence to other capital providers that management is
deeply committed to the growth prospects of the business.
One option for the existing management to fund the MBO is to borrow from banks or other debt
providers. Debt providers will often consider MBOS as risky and will require management to invest a significant
sum of capital, proportional to their ability to contribute, as a method of ensuring commitment.
For businesses with exceptional risk profiles, debt providers may only be willing to offer Mezzanine
Financing. These are financial instruments, with higher interest rates, which combine certain debt and
equity components into a hybrid solution without diluting ownership. This is typically only used for
those businesses or transactions with higher levels of risk.
The seller may wish to finance the buyout through a Seller’s Note or some other form of debt
instrument, typically amortized over the loan period. In certain unique circumstances, the owner may
wish to “roll their equity”, meaning that in lieu of cash consideration they will accept an equity stake in
the newly formed entity.
In addition to financing and rolled equity, Sellers can provide additional support to the newly formed
entity in the form of a Supply Agreement. To learn more about Supply Agreements, click here.
Management may also look to Private Equity groups to finance an MBO. PE groups will provide capital in
exchange for an equity stake in the newly acquired company. They will often require that the
management invest a significant sum of capital, proportional to their ability to contribute, to tie-in the
vested interest of the management with the company’s success.
For advisory on how this and other solutions may benefit your company’s corporate restructuring,
please call FabExchange at 408-560-2900.
To schedule a confidential discovery call regarding how Private Equity or an MBO strategy can benefit
you, please reach out to Rahn Amitai, Vice President, at 206-335-5140 or by email at
Rahn.Amitai@JDMerit.com. Visit www.JDMerit.com to learn more.
By Rahn Amitai, Vice President at JD Merit