Six risk factors that can cause MBOs to falter

Written by Tom Montague.

If you type ‘management buyouts’ or ‘MBOs’ into your news search, you’ll see a stream of deals that have just reached completion crowd your results, naming companies that range from regional firms to multinational enterprises.

They’re evidence of how MBOs have gained momentum over the last two years, driven primarily (experts say) by the availability of investment opportunities. This is due to businesses facing financial distress or underperformance, thus prompting managerial teams to see MBOs as a way to take over control and effect change for the better.

Some analysts now see MBOs as a defining feature of the UK’s corporate landscape, with the model serving as another blueprint for success for companies navigating uncertainties in the post-Brexit/post-pandemic business environment.

Definitions abound, but briefly put an MBO is a company acquisition in which its existing senior employees become its new proprietors by purchasing it from the incumbent owner(s), using their own finance and/or a private equity investment or third-party borrowing.

Prosperous MBOs align the experience of the management team with previous company success more closely than other acquisition models. The management team’s in-depth knowledge of the business can also help mitigate the risks of this kind of takeover.

However, despite the available executive qualities, whether incoming teams possess the managerial skills required to successfully helm a company under its new flag of ownership is often unproven, and  completing an MBO is no guarantee of leadership acumen – especially given today’s dicey market conditions. 

According to Fortune and others, management buyouts have a high failure rate. Andy Nash, author of ‘The MBO Guide for Management Teams’ describes MBOs as being ‘inherently risky [and] fraught with danger’.

So, what are some of the pitfalls that cause MBOs to go awry? Analysts suggest they can be linked to multiple reasons, each of which carries a tangible risk quotient. Here’s a concise checklist of six risk factors that MBOs should watch out for… 

Risk 1: Shared vision

The possibility for internal disagreement during the period that the MBO is in negotiation an ongoing hazard. One way to resolve differences of opinion among a nascent management team and its stakeholders is through the written articulation of a shared vision for the newly restructured business.

This mission statement may include operational principles, unifying declarations undersigned by the MBO team, or a declaration of objectives and performance targets.
Such core principles feed through into to-market messages and positioning statements. Continuity is crucial. It’s important, however, that the vision does not diverge from the founding culture that the business has thrived by. Any discord between top-down messages and signals can demoralise and destabilise the venture.

Risk 2: Financing hangovers

Raising financing represents one of the thorniest challenges for MBO teams. Most do not have all of the capital needed to acquire a company outright and rely on external financing options to supplement their offer.

This can result in the MBO carrying encumbering debt into the post-buyout period, which may bring about cashflow problems, thus limiting its ability to invest or mitigate its ability to outride unexpected economic downturns.

Risk 3: Management competencies

An MBO can be hugely time-consuming – especially if it runs into hitches that prolong resolution of the deal. As they get deeper into the process, it might emerge that the MBO team needs specific coaching and study, plus ongoing assessments and feedback to prepare them for taking over and running the business.

Having to call in external trainers can add unbudgeted-for operational costs to the MBO, so MBO teams would be prudent to factor this into their plans.

Risk 4: Continuity of operations

The management team can also face huge pressure to maintain business continuity while the buyout is going through. Balancing day-to-day operations with buyout negotiations can be onerous to those involved and tangibly add to their workloads.

The process will make additional demands on their schedule, and this carries the risk of shifting focus away from the effective execution of their core responsibilities toward the business. The personal impact on an individual’s life outside of the workplace also has to be considered.

Risk 5: Workforce backing

MBOs are generally thought to be viewed positively by employees because members of the former managerial team are now the company bosses. However, this should not be regarded as a given.

Despite a new team’s best intentions and good faith to do right by the workforce, interpersonal or professional differences may affect the extent to which employees get behind the new leadership composition and direction.

If this disconnect is not addressed by the new team as part of the MBO bid, disaffection can lurk among employees who may well have preferred their previous owner’s style.

Risk 6: Sustainable cashflow

An MBO is often financed through a mix of capital debt and equity. The management team typically secures bank loans backed by company assets or personal guarantees, sometimes supplemented by private equity. 

This can heighten financial risk if the business later experiences cashflow issues. For instance, if a transport or logistics company undergoing an MBO is struck by a surprise rise in fuel costs, the additional debt could threaten its financial stability.