Buying out the boss

Posted on: September 13th, 2018 by Seamus Gates No Comments

Seamus Gates, looks at why management buyouts (MBOs) and employee buyouts (EBOs) can work as succession routes to ensure a smooth transition and continued business success.

The concept of succession planning often does not appear on the priority list for many business owners who are heavily consumed with the day-to-day operation of the business. In reality, however, planning for succession it is a vital aspect of ensuring a business’ longevity as it addresses the need of an owner to have a well-planned exit strategy but can also help those who step up to take over the reins of management.

There are two distinct ways that this can be achieved.  Firstly, through a management buyout – where the senior management team steps forward to take on the business – or employee buyouts, where workers at all levels in the business, from the shop floor to the leadership team, become the new owners under a co-operative arrangement.

Either form of buyout can arise from a number of circumstances, including the owner deciding to sell or retire from the business, or the business experiencing a difficult trading environment.  A well-planned succession by the owner should avoid the latter.

Over recent years we have seen MBOs re-emerging as a popular succession route, largely driven by improving access to finance. Clarks Modular Buildings, 1st Choice Accident Repairs Limited, Javon Products Limited and Newhall Janitorial Limited are just a few examples of successful MBOs in Wales that MHA Broomfield Alexander has advised on within the last 12 months.

The best MBOs will have been considered carefully in advance and will have involved substantial planning, often meaning a gradual exposure of the management team to the day to day running of the business and strategic decisions over time.  In some cases new team members are brought in to strengthen the management team ahead of an MBO.

There are a number of advantages of an MBO over selling to an external buyer: potentially better job security for the workforce; continuity for customers and suppliers; less disruption overall as the deal requirements are completed with full cooperation and understanding; and a greater chance of success and legacy, as the management will already have an in-depth knowledge of the business, its products, services and markets.

It is a common misconception that the management team needs to fully fund an MBO by itself. Often, third party investors such as banks and asset financiers can provide secured funding and this, together with more expensive unsecured funding, will often provide the vast majority of capital required. The management team will often be required to contribute an amount which is seen as reasonable in the context of the overall deal – something that demonstrates a financial commitment from them and ensures they have a financial incentive to ensure the MBO is a success.

Achieving the right mix of skills across the management team is crucial, but can sometimes prove difficult.  Identifying and addressing any gaps at an early stage will enhance the chances of a successful MBO. The MBOs that enjoy most success are built on a foundation where those seeking to run the business have a good blend of skills and experience that will ultimately help shape its future prospects.

A less common and conventional route to succession is the employee buyout, where the employees as a group take the business forward and where the business operates more as a co-operative.  A clear advantage being that the business is passed to people who have a vested interest in its future health and success. An employee buyout can circumvent the need for a potentially hostile business sale and sometimes save the company from unnecessary redundancies.

Arguably the most important element of an employee buyout is time. Both the business owner and the employees need time to analyse and assess whether it is the right option; to put plans in place for continuity; seek proper financial and legal advice; and to train staff members in new roles. There will then need to be a sharp focus on communications – both internal and external – in order that clients and customers, as well as the employees themselves, are well prepared to adapt to changes implemented as part of the process.

Employee buyouts can often result in a boost in staff morale, although this needs to be tempered with the reality of ensuring that the employees are fully capable of taking on the challenge of running the company effectively and efficiently. The culture shift that is needed for a group of employees to become successful employee-owners is significant and shouldn’t be underestimated.

There are various lenders that will finance employee buyouts, including banks and co-operative lenders. The Development Bank of Wales is one example of a lender that works with co-operative lenders to syndicate funding for employee buyouts. There is the option to offer shares that can be bought by an employee trust and, in cases where the business owners are particularly supportive of an employee buyout, they have chosen to sell to their employees for less than the full market value or to accept payment gradually. Depending on the way the buyout is financed, there can also be tax advantages.

Ultimately, whichever option is chosen, both buyouts require proper planning and thought – and, as with any major business decisions, there is no time like the present to begin preparing.

This appeared as an article in the business pages of the Western Mail on 16 August 2018.

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