Management Buyout- Step by Step Approach and Valuation

Management Buyout

Management buyout transaction is similar to leverage buyout. In Management Buyout the managers buy their company from its owners employing debt. The debt typically ranges from 70 to 90% of the deal price. In this case Mangers purchase the asset and business operation they manage. They expect a potential return from the deal. They try to maximize their return by becoming owner of the business than employee.

MBO is turned out to be favorable as the company is taken over by existing management team than selling it to outsider.

Risk associated with Management buyout

MBO is similar to LBO. In MBO external financing is required as managers will not have sufficient fund for complete takeover.

  • Equity holder
  • Debt holders

Return associated with Management buyout

Managers go for MBO to increase in return. Managers expect high return by acquiring the firm and running it efficiently.

  • MBO Evaluation
  • Steps involved in Management Buyout
  • Issues related to MBO

Risk associated with MBO

MBO is similar to LBO. In MBO external financing is required as managers will not have sufficient fund for complete takeover. MBO is associated with following risk.

Equity holder: As mostly finance by financier there will be restrictive covenants from financial institution point of view. These covenants can interfere in general activities of the new firm.

Debt holders: The debt holders bear the risk of default equated with higher leverage as well, but since they have the most senior claims on the assets of the company, they are likely to realize a partial, if not full, return on their investments, even in bankruptcy.

Want to go for a management buyout? Here's how to approach it.

As part of a management team who wants to engage in buying out some of the divisions orcurrent owners of private businesses, you’ll have to make use of a thoughtful approach. Be sureof what you want and plan out the best way to approach the owner.Put up a proposal that will outline the reasons why you want to buy the business, what you thinkthe business is worth as well as your budget, and what financial method you choose to use inthe purchase of the business.
Another thing is to carry out your due diligence, build a financial model, knowhow to calculatebusiness valuation,and perform a thoroughbusiness valuationanalysis.Knowing the members of the management team, including those who will be involved in thebuyout and those who will not be participating is also very crucial. This way, you’ll knowhowbest to distribute equity in the transaction.In thevaluation of a business for sale, professionalsurveyors and evaluators should beemployed to conduct a properbusiness valuation service

Financing Options For Management Buyout

Management buyout generally needs sufficient funding. Different options are available in the financing of a management buyout, let’s take a look at a few of them.
1. Debt Financing
A company may not necessarily have enough financial resources for buying a business. The first option available for the company is to borrow from a bank or other sources. In the case of borrowing from a bank—depending on the funding source or the bank’s decision on the management’s resources—the management team is expected to provide a significant amount of capital, while the remaining amount required for the buyout will be provided by the bank as a loan. There are different forms of debt financing—most of which require appraisal and valuation from surveyors or business valuation companies. This includes:
Non-bank cash flow lending: This is done based on the potential growth of the company. Lenders use advanced computer software and algorithms to determine the company’s growth.
Debentures: a type of bond or debt instrument secured only by the general credit of the issuer and backed up by the reputation and performance of the company rather than collateral.
Real assets lines of credit: This seems a very easy kind of debt financing but with associate drisk. Companies borrow against the value of their real assets. The risk comes when the business doesn’t yield what was expected from it. The lender may request a assets valuation to know what the home is worth.
Recurring revenue lending: It’s a form of debt financing that is common for cloud-based tech companies or those that focus on Saas. Lending is done based on the company’s income and its subscription services.
2. Mezzanine Financing
Mezzanine financing combines equity and debt by taking out and merging—without ownershipdilution—certain financing features that will enhance the equity investment of a managementteam. In priority, mezzanine debt typically ranks below senior debt but comes above equity andmay take different forms which include junior debt, privatesecurities, subordinated debt, orconvertible debt.The mezzanine option is mostly sought by management teams looking for a higher return inequity and a flexible repayment term.
3. Seller/Owner
FinancingThis option particularly is a popular source of financing in management buyouts. The process incertain cases involves an agreement where the seller offers to finance the buyout through aterm loan which is amortized over a period of years. The amount charged at the time of sale isthe face value of the main amount, the real amount is charged over the years from thecompany’s earnings
Management buyout

Return associated with Management Buyout

Managers go for MBO to increase in return. Managers expect high return by acquiring the firm and running it efficiently. As MBO is finance by financier, there is expected return of lender from the deal. A lender provides high leverage with anticipation that firm will fully utilize the potential of the business. Lender perceived risk is lower than its expected return.


Lender perceives that firm will have optimum return from this deal. Lender evaluates investment opportunities with by analyzing expected internal rates of return (IRRs), which measure returns on invested capital. IRRs represent the discount rate at which the net present value of cash flows is zero.

MBO Evaluation:

The evaluation technique in leverage buy out is same as other Mergers and acquisition technique. Discounted cash flow technique is used. There are certain steps involved in MBO evaluation.

Steps involved in Management Buyout:

  • Estimation and projection of operating income; basically EBDITA to know the cash flow available for debt repayment.
  • Determination capital structure with individual cost of capital.
  • Calculation of Internal rate of return of firm
  • Based on the above parameter valuation price can be determined.

Issues related to MBO:

  • It can create conflict between managers of acquiring firm and the shareholders of the firm. The shareholders benefit will reduce if the deal is very attractive for managers. This gives rise to agency cost. It is the responsibility of board to protect the interest of shareholders and ensure that the deal offers fair value.
  • Another issue is the price of the target company’s debt instruments. Debenture holder may demand return at par with ownership as majority of finance is being provided by them.

Management Buyout is applicable and favorable in those cases where owners wanted to retire from the business and managers are capable enough to take over the firm. This deal logically makes sense, as managers know in and out of the business operation of that particular entity

Management buyout