The main pitfalls in a management buyout/-in

A key risk in an MBO or MBI is the dependence on one or a limited number of person(s), often the seller or a key person within the company. The seller’s network, expertise and reputation often play a major role in the company’s success. Once this person leaves, the company can find itself in a vulnerable position. This is especially true for small companies or those with limited EBITDA, where there is a greater reliance on individual contributions.

A solution may lie in a sufficiently long transition period, with the seller remaining involved for some time, as well as an earn-out arrangement that makes payment of the sale price conditional on the achievement of certain milestones. Both systems  allow the buyer to gradually gain more control over the business and mitigate its risk of losing profitability.

Rather 10% of a large company than 100% of a smaal company completely dependent on one person.

A common mistake or oversight in an MBO or MBI is carrying out insufficiently comprehensive due diligence. The desire to finalize a deal quickly is understandable but should never come at the expense of comprehensive analysis. While reducing upfront costs may appear advantageous, insufficient due diligence can result in unforeseen complications post-acquisition, with the consequences of such “deal fever” potentially proving disastrous.

Professional due diligence can identify risks and help the buyer make more informed decisions. In doing so, it is essential to take potential red flags sufficiently seriously. If clear warning signs arise, it is crucial to have the foresight to either abandon the transaction or renegotiate its terms. Moreover, involving an external advisor is highly recommended, regardless of the transaction’s size. External experts are often better positioned to identify and assess risks, offering valuable support in securing appropriate contractual guarantees.

Red flags but deal fever? Walk away or renegociate the deal!

Financing a management buyout or buy-in is often one of the most complex aspects of the process. A solid financial plan is the backbone of a successful transaction, but putting together an effective financing structure also requires some creativity and very thorough preparation. A common challenge is the limited ownership of the acquiring management. In such cases, external financing such as bank loans, loan from the friends or family, or a vendor loan is often resorted to.

Disengaging from bank financing, the most obvious source of funding, requires a comprehensive and well-substantiated financial plan that provides sufficient buffers, for instance in terms of EBITDA or cash on closing. After all, you don’t want to experience a situation where the financing in terms of repayment is so tight that the company can no longer meet its obligations at the slightest setback. In that respect, we therefore recommend carrying out multiple scenario and stress tests.

Obtaining a vendor loan requires a certain level of goodwill from the seller, who must be willing to assume risks, as their financing is subordinated to the bank (meaning repayment occurs only after the bank has been fully repaid), without any concrete security. To mitigate this, the buyer can offer solutions such as entering into a refinancing agreement during the term of the bank loan (subject to the bank’s approval), pledging the target company’s shares (in second rank), signing an asset conservation agreement, or, in the most extreme cases, providing a personal guarantee. However, in the event of bankruptcy, the situation may vary: the repayment of the seller’s loan may, under certain conditions, occur simultaneously with the bank loan, depending on the specific terms and agreements laid out in the financing contract.

More creative financing solutions can be found, among others, in the win-win-loan , a subordinated loan provided by friends or family that is registered on PMV’s platform and qualifies as additional equity for the bank.

The lack of clear financing agreements prior to the closing of the transaction can jeopardize the future continuity of the business, particularly if the seller is also reinvesting as a minority shareholder in the new transaction. It is therefore crucial to establish appropriate agreements regarding future financing and exit strategies. Examples of such agreements include the financing waterfall (with the first pro rata additional payment made via a subordinated loan, followed by a capital increase in the second order) and the inclusion of call/put options.

Solid and diversified funding is the backbone of any succesful MBO/MBI

If the seller is willing to reinvest part of the proceeds in shares of the new holding structure, it can signal confidence in the company’s future growth and the partnership with the new owner/manager. However, caution is necessary: a reinvestment does not necessarily guarantee the seller’s long-term commitment.

It is essential to establish clear agreements regarding his role after the transaction to prevent him from either exiting prematurely or blocking the company on critical decisions or financing matters. Ensure robust governance agreements are in place and avoid allowing the reinvestment to serve as a mere smokescreen. Remain vigilant, maintain sufficient distance, and, above all, stay objective.

Surely 40% reinvestment is enough skin in het game?

A successful MBO or MBI requires meticulous preparation, clear agreements, and a well-structured financing plan. Failing to identify risks such as excessive reliance on key stakeholders, insufficient due diligence, or inadequate financial buffers can quickly turn the transaction into a major setback. A reinvestment by the seller can signal confidence in the new direction, but it demands careful evaluation and clear agreements on future commitments regarding operations, governance, and funding.

“Stay calm, maintain sufficient distance, and always remain objective.” With a thoughtful approach, the right expertise, and a realistic business plan, the typical pitfalls of an MBO/MBI can be transformed into a successful, balanced transaction that fosters sustainable growth and value creation.

***

If you have any questions or if you would like more information, do not hesitate to contact Alexia Colpaert or Wim Van der Meiren.