At a glance
- MBIs have disadvantages for the private equity firm and the team itself
- Entering into such a deal requires increased due diligence and more of a focus on exclusivity agreements
- A BIMBO would help some of the issues that can arise, but also potentially cause problems between two unfamiliar teams
- The levels of trust required mean that any partner should be chosen very carefully
Management buy-ins (MBIs) are often seen as much harder to achieve than management buyouts. The private equity house can't get the inside story from managers who are running the business on a day-to-day basis, nor the comfort that the incumbent management team, who know where the skeletons are buried, are willing to make a significant personal investment in the business.
From the MBI team’s perspective, these transactions can also be difficult as they may have done a lot of the groundwork to put the deal together but do not have the protection of being “in the business”. There is therefore potential to be cut out of the deal once it has been introduced if they have teamed up with an unscrupulous backer.
There are, however, ways of seeking to mitigate these issues:
Increased due diligence
On an MBO, a firm can take comfort from the fact that typically, the incumbent team are prepared to invest their personal wealth into the business. Also, as a buyer alongside the firm, incumbent management are incentivised to disclose the “warts-and-all” picture to the investors, giving them the inside track as to where to focus their due diligence. The firm may not have this inside track on an MBI. As a result, we have seen that MBIs are more prone to abort as due diligence issues can come out of the woodwork at a later stage in the process than with an MBO. This puts an added emphasis on due diligence, warranties and disclosure to flush out the issues that in a normal MBO would no doubt be discussed at an early stage between the team and private equity house.
BIMBO (buy-in management buyout)
If it is possible to involve a mixture of a buy-in team and existing management, this can help mitigate due diligence issues. A BIMBO brings its own issues in terms of ensuring that the two sets of managers can work with each other in future. It is also critical that their roles are clearly defined in order to avoid friction between the existing and incoming management team.
If a firm is working on an MBI with a buy-in team, it will be keen to have exclusivity with that team to minimise the risk of it joining forces with another firm or potential bidder. This can be a difficult issue unless the MBI team and the firm are both of the view that they would not pursue the deal unless the other is onboard. It is likely that exclusivity will be something that private equity will want early in the process; however, this is likely to be before management equity terms have been finalised, and certainly before there are binding equity documents in place.
If an MBI team are bound to a firm at an early stage in the process, this clearly weakens the team’s negotiating position in relation to equity terms. As an MBI team do not have the incumbent management team’s protection of being involved in the target business, they will want some comfort that the firm will not cut them out once they have done the groundwork, so will want it to agree to work exclusively with them. This is a difficult issue for firms too, as at an early stage of the process they may not have got to know the buy-in team well enough to commit to only work with them on the transaction. In addition, if the firm commits to only work with the buy-in team then this puts them in a weaker position when negotiating the equity documents (particularly if it is bearing the bulk of advisers’ fees and therefore may be unwilling to step back from the deal at a late stage of the process).
If exclusivity is to be entered into, we would recommend that this is tied to an agreed set of key equity terms that can be reflected in the final equity documents. As an equity term sheet is likely to be non-binding, again there is an element of trust and co-operation that will be required. It is of vital importance for a management buy-in team to carry out detailed due diligence on their private equity partners and take references from previous management teams before undertaking a MBI with a particular backer. It is also important to get at least the key equity terms agreed at an early stage.
As set out above, MBIs, even more so than MBOs, require a strong degree of co-operation and trust between backers and team. From an MBI team’s perspective, it is key that they choose their partner carefully. Certain firms have particular models, processes and/or deal requirements that make them less natural partners than others. Also, given the emphasis on trust and co-operation, it is important for an MBI team to pick a backer that sets an emphasis on co-operating with management teams and on reputation. It is also important to pick a firm that is prepared to deal with the added complexities (and potential risks) of undertaking a MBI.
Clearly it is possible to achieve a successful MBI, but it is more difficult than an MBO and the parties need to seek additional protection to protect their position. This is important both from the perspective of management teams and private equity houses. It is crucial to a successful MBI to choose your partners carefully.
Malcolm MacDougall is head of private equity and Adam Crossley is a senior associate in the private equity team at Speechly Bircham LLP.