Business Article - Management Buyout
The term Management Buyout by definition is the acquisition of a company either as whole or in a large part by its existing managers. Management buyouts, in major legal aspects, are essentially the same as other types of company acquisitions. The main difference in this case being that the buyers are the existing managers of the company, rather than an outside entity altogether, who will carry any and all consequences that may follow. One such consequence of this process would be a more limited “due diligence” process.
Due diligence is essentially the process where a potential buyer makes and evaluation of the targeted company or its assets for purchasing. The reason that the time period for this might be limited is due to the fact that one could assume the managers of the company would already be fully in the know about the company’s strengths and weaknesses, and so on, so they wouldn’t need nearly the same amount of time to evaluate the worth and the risks involved. This would also go without saying that any warranty being offered by the seller would be no more than the most basic, for exactly the same reasons the due diligence process would be limited or shortened as a result.
There are concerns in regards to management buyouts relating to asymmetric information that may be possessed by the management that could offer them an unfair advantage in relation to the current owners of the business. Asymmetric information, in a nutshell, is defined as when one party holds more information about an item or a transaction than the other party could reasonably hold. This is really no different than your average everyday transaction, such as with a used car dealer, with mortgage and loan people, through real estate brokers, life insurance agents, and just about anyone else who would have detailed knowledge of a specific trade or industry.
The possibility of a management buyout could end up leading to “principal-agent problems, “moral hazard”, or worse yet, inconspicuous downward manipulation of stock worth prior to the sale through adverse disclosure of information. This would include aggressive and accelerated recognition of loss, launching dubious projects in public and adverse earning surprises. Principal-agent problems are a problem related to asymmetric information. In essence, the principal-agent problem is what arises from employer/employee relationship. Both parties act in self interest, but in most cases the agent knows more than the principal, and can act under his or her own motives. Moral hazard is a reference to the idea that a party is protected from risks and won’t be as concerned about consequences of those risks.
Of course, this kind of corporate governance will exist when the current upper management can benefit personally from selling their company or their assets. Included would, for example, be large quitting bonuses for the company CEOs post-takeover or management buyout. Because corporate value is often the subject to uncertainty and/or ambiguity, and because it can be highly influenced by asymmetric info or inside info, some people question the validness of a management buyout, and feel that they represent a type or form of insider trading.
The Purpose of an MBO
The general purpose of a buyout from the manager’s vantage could be to save their jobs if the business is scheduled for closing or if the purchaser would be bringing in a new management team of its own. It is also possible that they want to bring success and maximize the personal benefit by taking profits. This is generally done to ward off encroaching buyers.
The financing of a Management Buyout --
Bank Financing --
In general, the company management will not have the necessary capital on hand to make the outright purchase completely on its own. So the first step is to seek out a bank that is willing to shoulder the risk. Unfortunately manager buyouts are generally seen as too risky to finance via a loan.
Financing via Private Equity --
If a bank cannot be found that will finance, then management will generally look for private equity investors to finance a large part of the buyout. A vast amount of management buyouts get financed in this fashion. The investors generally invest the money in exchange for a portion of shares in the company, though sometimes they may allow a loan to be made to the management as well. The structuring of the financing will depend on the financer’s desire to balance risk versus return, in which debt tends to be less risky, but also less profitable than a capital investment would be.
While management might not have the resources to purchase the company, the private equity houses will expect that managers each the largest investment they can afford to, so to ensure lock in of the management by a staggering vested interest of the company’s success. It is quite common for management to re-finance their own homes to acquire a percentage of the company.
Private equity backers tend to have much different goals when it comes to the management. They are generally looking to maximize their return so that they may make an exit within three to five years while still minimizing personal risk to themselves. The management on the other hand will probably not look beyond their individual careers at the company, and will instead take a long-term view. Certain aims do tend to coincide however, including the primary aim that is profitability. This does not mean that certain tensions will not arise over time, however. Backers tend to want to impose warranties on management, especially in relation to the company that the sellers refused to give to the management. This gap, known as a warranty gap, means that the management will be responsible for bearing all of the risk if any defects arise that affect the value of the company.
As a condition of the investment being made, backers also tend to impose a set of terms on the management that concern how the company is going to be run. The purpose of these imposed terms has to do with ensuring that the new management will run the company in the right way, so that returns will be maximized during the period of time where the backers are actively investing in said company. The management may have hoped to build the company in such a way that it receives long-term gains, but the backers impose these restrictions to ensure that their investments are well spent. Although the aims of the backers and the aims of the management team are sometimes compatible and sometimes not compatible at all, the management may still feel very restricted in some aspects of the business.
Vendor Financing –
In certain circumstances pertaining to the management buy out process, it may actually be possible for the management and the person who originally owned the company to come to an agreement on a deal which allows the seller to completely finance the buyout process. The price that is paid at the time of the sale will actually be fairly nominal, with the real price being something that is paid out over the following years, as it will be drawn from the profits being earned by the company on a yearly basis. The typical time scale for a payment period like this is between three and seven years depending on the agreement.
This actually represents a disadvantage for whoever the vendor is, because he or she has to wait several years to receive all the money, though he or she has already lost control of the company. The vendor is also quite dependent on the returned profits increasing slightly following the company's acquisition in order for the seller to receive a gain of any kind in comparison to whatever situation was present at the time of the sale. Although this only occurs occasionally and in particular circumstances, it is still a circumstance worth putting some consideration into. Still, the vendor may decide to agree to vendor financing based on tax reasons or tax benefits, because this consideration is considered to be income rather than a capital gain and may benefit the vendor as a result. It may also allow the vendor to receive some other types of benefits, including a purchase price that is higher overall than what could be accomplished through a normal business sale.
Example of a Manager Buy Out –
Here are some examples of MBOs or Manager Buy Outs:
- The Springfield Remanufacturing Corporation was originally owned by Navistar, but was in danger of being closed completely or sold to an outside party before the manager team bought the company.
- The United Kingdom company New Look was the subject of an MBO in 2004 by the founder of the company who floated it in 1998.
- The United Kingdom branch of Virgin Mega stores was sold off as part of a large-scale management buyout. This branch of Virgin Mega stores was renamed to Zavvi in 2007.