What is Management Buy-out (MBO):
In an ideal MBO, financial institutions or other fund lending institutions act like venture capitalist and support management of the company in buying out stakes from the promoter(s) of the company. This changes the control of the business. The entire business or a division may be bought out under an MBO deal on a going concern basis. The main ingredients behind the MBO are
- Company’s management creates and completes the deal
- Either sale of a division or sale of promoter’s stake
- Business is sold on going concern basis
- Control changes from the hands of promoter’s to management
- A third party, normally Financial Institution, backs up the management financially to buy out the controlling stake
Rationale of MBO deal from existing promoter:
- The company intend to unlock the value of business by selling it which it considered as non-core
- Promoters are no longer interested in continuing the business or consider it a non-profitable and looking for other parkway for their funds.
- The promoters does not have any succession plan and over the period, the management has understood the business well and can take it ahead with same vision, values and similar pursuit.
Differentiating factor between and Ideal MBO and other restructuring:
Prime motive of all these kind of restructuring could be to unlock the value of the business by separating the non-core business from the core. One way of separating the business could be demerger. But, generally the demerged business is created as separate legal identity and controlled by the same promoters. Thus, many a time the motive of management to focus on the core business is lost. In MBOs, there is no new legal identity as such is created. On the other hand, in MBOs, management with its clear understanding of the business, runs the company after acquiring the controlling stake.
B: Deal structure and parties involved
In other kind of restructuring, deal structures are generally different from those in MBOs. A simple acquisition of the promoters’ stake may not involve debt from financial institutions. A leveraged buyout involves using debt from financial institutions to fund the acquisition but it is different from MBO as in leveraged buyout the buyers are outsiders and in the case of MBO, it is the existing management.
Like leveraged buyouts, MBOs have same financial risk but since the same management is running the business, the risk of losing vision and values is very low, which gives positive signals to the smaller shareholders
What are the probable industries where MBOs are critical/important?
MBOs are important for all those industries where senior employees/management is critical, for example Pharmaceutical, software and other intensive research based industries. As the top executives are very important, these sorts of companies are ideal for MBOs rather than selling stake to any outsiders.
Also Read: Optimal Exit Strategy for a Business Owner
Distressed companies will benefit much from MBOs. Promoters would like to exit the business. If management is confident enough to revive the business then, these companies would be ideal to undergo such deals
Why not enough MBOs in India are happening?
Some critical reasons for dearth of MBO deals in Indian scenario are:
- Non-separation of ownership and management control– Companies, which started one or two decades back or earlier, were run by family members. A kind of inherited business model has been adopted by most of the companies, be they big or small hence there is hardly any division between management and ownership.
- Lack of pragmatic approach among the promoters– It is general perception of Indian promoters and the employees/ management that they are capable of running their businesses efficiently, which may not be true.
- Lack of deep pocket- Even if the ownership and management is separated in some companies, the management does not have the financial strength to acquire the stake.
- Lack of participation of lending institutions- Banks and FIs are not willing or constrained by legal hassles to participate in the MBO deals. The Few instances of non-typical MBOs have been seen in India only due to investment and business models of private equity firms.
- Low risk taking phenomenon among the management– Indian management, other than promoters are not willing to take risk running the business.
Promoters who do not have competent successors will find MBOs one of the effective tools to run their businesses. Companies should consider MBOs as one of the strategic alternatives to create more value. Promoters should not hesitate even selling their controlling stake to the management because they have potential to bring better days for the company and in the process promoters’ name will still shine in the company. Management Buy-In could be tried out by the promoters if they do not find the internal management competent. Regardless of the alternatives the company chooses, Bankers and financial institutions should be proactive and understanding in this form of restructuring by providing the required financial inputs.