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Also known as an MBO, a management buyout is when a company鈥檚 existing leadership team works together to purchase either a total or majority stake of a business. This typically happens in private companies when the owner retires and company management coordinates a 鈥渂uyout鈥� in order to take full control.聽

When executed effectively, MBOs can be a win-win for buyers, sellers, investors, and shareholders. Since all sides are already familiar with each other and the company, the transition process is often smoother when compared to a buyout where an outside party is involved.

Management buyouts can happen in every industry to businesses of any size. If you鈥檙e a business student, or have your sights set on a leadership role, you鈥檒l likely come into contact with this concept at some point in your educational or professional career. For this reason, it鈥檚 important to achieve an understanding what an MBO is and how it works. This guide will break down both.聽

The management buyout process typically follows a series of steps that include:

• Step 1: Performing a company analysis
• Step 2: Negotiating a company鈥檚 selling price
• Step 3: Financing the buyout聽
• Step 4: Creating a transition plan
• Step 5: Transferring ownership, knowledge, and capabilities to new management聽

The entire process can be a short term or long term process taking anywhere from six months to several years, depending on the size of the company, involvement of investors or lenders, cash flow options, and many more factors. Organizations typically continue normal business operations until the transfer of ownership takes place.

Management Buyout vs. Management Buy-In

Both are methods to sell a company, but they have one key difference. With a management buy-in, external management is brought in to supplement or replace the existing management team, whereas in a management buyout situation, the existing management team remains intact.

It鈥檚 common for management buy-in to happen when a company is improperly managed or undervalued in the market.

There are multiple ways to acquire a business. When compared to the alternatives, there are upsides and downsides to choosing a management buyout.

Advantages

• A faster, smoother, less costly process. Buyers already have intimate knowledge of the company and less due diligence is required.
• A greater potential for long-term success and increased profits. The new owners already know the business and are able to hit the ground running, versus the time and money it would take to onboard an external buyer.
• More opportunity for career advancement. MBOs often lead to reorganization, which can identify deficiencies and create additional job opportunities within the company.

Disadvantages

• A more difficult transition from employee to owner. It can be difficult for some owners to let management take the reins in a buyout transition. Similarly, management involved in the buyout have to change their mindset from employee to owner, which can also be challenging.
• The potential for conflicts of interest. There鈥檚 a greater risk of loss to the seller during a management buyout because it rarely provides the owner with the highest purchase price.聽
• A lack of experience. An internal buyout is often a management team鈥檚 first time in a leadership position. In some cases, the management team may lack experience in running a business.

Raising money is an important part of the MBO process, but it鈥檚 not always easy. The good news is, there are a number of options available, depending on the size of the acquisition.聽

Small Transactions

A small transaction is considered anything with an acquisition price below five million dollars. Most rely on financing backed by the U.S. Small Business Administration-backed financing and use a combination of these funding sources:

• Equity from an acquiring team聽
• Seller financing聽
• Individual investments
• Small business loans
• Family loans

Large Transactions

Any acquisition price above five million dollars is considered a large transaction and will have more financing options, such as:聽

• Junior and mezzanine financing: paid only after senior lenders are paid.
• Senior debt financing: provided through loans that have a first security position on the company鈥檚 collateral.
• Private equity (PE) investments: may consist of equity, senior debt, or mezzanine debt.

Post-Acquisition

Regardless of the transaction size, there are financing options available even after the transaction is complete. The two most common ways to finance operations after an acquisition is either via bank financing or accounts receivable financing (also known as invoice factoring, which is a way for a company to raise money by selling invoices to another company at a discount).聽

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