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What is the value of an MBO?

It is a popular misconception that selling a business to the management team means doing so at a discount. I’ve lost track of the number of conversations I’ve had, with business owners who would like to sell to someone inside the business but assume that it won’t be possible. Knowing that the successor does not have the cash on hand leads founders to assume that they will have to let their business go for a song. I assure you, that is not the case.

In IFA deals, a buyer will agree to pay some of the total purchase price to the seller upfront (when the deal concludes). Market dynamics dictate that this initial capital amount is somewhere in the region of 40% to 60% of the total, with the balance being paid over a few years thereafter. Of course, many buyers don’t have sufficient capital and that is where debt financing comes in. If a buyer is borrowing commercially, the debt can usually be spread over five to eight years, but repaying the debt is not the same as paying for the deal.

Paying for the deal is a calculation of the time it will take to accumulate sufficient free cashflow to cover the total cost of the deal. That means the total consideration payable, regardless of how it is financed. Just as a reminder, free cashflow is post-tax profit, less the cost of funding the business.  What this should tell you is that you can justify almost any sale price, on a long enough timeline.

The timeline is really the important factor. Over what period are you, the seller, willing to receive your money? You could be incredibly generous and let the buyer pay you over say five or even six years, with no money upfront. The combination of price, tax and credit risk will likely put you off such a move. In most instances, if you sell an asset you pay tax when you sell it, not when you receive the money for it. You don’t want to sell a business and be out of pocket for a period due to the tax bill. Furthermore, if you sell an asset and don’t receive the full consideration straight away, you become a creditor to the business. This means sharing risk over the payment period.

What we’ve seen work well, is a situation where you get a fair market price, with most of the money paid at completion and the balance (deferred consideration) paid over a sensible period, backed up by a business plan that helps you get comfortable with the risk. Given the dynamics in an MBO, where the buyers purchase a minority portion of the business upfront, we have also seen the seller receive the full payment upfront!

So, before you conclude that an MBO won’t work, spend some time on financial forecasting. Think about the next ten years of revenue, direct costs, gross profit, expenses and tax, initially on the basis that everything stays the same. That will give you a baseline, which you should be able to stick with in doing a well-executed MBO. Then think about how that baseline might grow over time if you do expand ownership to bring in more energy and skills. Importantly, remember that the benefits of an MBO go beyond just financial – the lifestyle benefits to expanded ownership are significant – you can live the life you want to live in the coming years.

For more information on how to execute an MBO, have a read of our new MBO Guide, which you can download here.

Matthew Marais