A management buy-in (MBI) is the acquisition of an existing business by an external manager who wants to become an entrepreneur. The process takes an average of one to one and a half years, typically requires at least a 50% personal investment in addition to bank and other financing, and demands a clear buyer profile, thorough due diligence, and the right advisers. The biggest risks are an unclear buyer profile, excessive dependence on the current owner, and the “winner’s curse” in a bidding war.
You want to buy a business. Then you are not alone. Research has shown that one in five people sometimes dream of starting their own business.
After building a successful career within a large corporation over the course of ten to fifteen years, many people start to feel the itch. They want to set their own course without constantly having to answer to a boss. For many of these managers, becoming an independent entrepreneur is therefore an appealing prospect.
In this article on management buy-in you will find:
- Why a management buy-in?
- Where do you start as an MBI candidate?
- Who is the most important person in an MBI?
- MBI roadmap: 10 steps to success
- How do you finance a management buy-in?
- What are the biggest pitfalls of a management buy-in?
Why a management buy-in?
The answer is simple: taking over a business is easier and involves fewer risks than starting a business from scratch. An existing business is essentially a well-oiled machine: revenue, customers, suppliers, staff—it’s all already in place.
Taking over an existing business also has the major advantage of generating immediate income. Of course, the purchase must be financed, but knowing that mortgage and living expenses can continue to be paid is a reassuring thought for many aspiring entrepreneurs.
Where do you start as an MBI candidate?
Buying a business is an exciting, intensive, and often emotional process. Moreover, it’s not something that can be wrapped up in a few months: an acquisition process takes an average of one to one and a half years.
Tip 1: draw up a clear buyer profile
Before you actually start your search, thorough preparation is essential. First and foremost, you need to know exactly what you’re looking for. Many prospective buyers search haphazardly and respond to a wide variety of listings online without a clear plan. If you don’t know what you’re looking for, you won’t find it. Another common mistake is that buyers fixate too quickly on a specific industry or company size. For example, a prospective buyer might come from the telecom industry and want to buy a business in the same industry at all costs. That seems logical, but it also limits the possibilities.
Tip 2: know your financial resources
Second, your own financial resources are crucial—whether or not they’re supplemented by investors who are willing to back you up. Banks are currently reluctant to provide acquisition financing. Expect to have to contribute at least half of the required acquisition amount from your own funds.
Tip 3: involve your partner, family and friends
Finally, during the preparatory phase, it’s very important to discuss your plans to buy a business with your closest circle. How does your family feel about your plans, and what does your partner think? Do they understand what you want and why you want it? Will they support you in this venture, even if it doesn’t work out? If you’re the primary breadwinner, do you have enough savings to get by without an income for a while, and what’s your Plan B if the process takes longer than expected?
In practice, it still happens that the partner is brought into the process far too late. The prospective buyer is already working closely with advisers, has even visited a business, and just as the initial negotiations begin, it turns out that the partner doesn’t support the plans. The buyer withdraws from the purchase process with an excuse, and the relationships with the advisers involved are ruined for good.
Be sure to discuss your plans with friends and your professional network as well. The search for a business can be a lonely process and lead to frustration. It helps if your personal and professional networks know what you’re up to, so they can support you when needed.
Who is the most important person in an MBI?
And let's not forget the most important person in this story: yourself! As mentioned, prepare yourself for an intense and intensive period. Especially if you also quit your regular job with all the securities and contacts that go with it, you will be thrown back on yourself completely.
Your surroundings can support you, an acquisition advisor and a good business network can help you, but ultimately you will have to do it yourself. After all, you are self-employed.
MBI roadmap: 10 steps to success
Achieving a successful management buy-in takes time, patience and effort. Brookz charts every action with a 10-step plan for a successful MBI:
1) Know what you want to buy. Create a buyer profile. What kind of business suits you in terms of industry, type and size of the business, region, risk, and stage in the growth cycle? A buyer profile provides direction and focus, and prevents you from wasting unnecessary time, energy, and money on businesses you’re not really interested in anyway. It also gives you a stronger case when talking to M&A advisors.
2) Bring in the right advisers. The various phases of the acquisition process require expertise; consider seeking help. To successfully buy a business, you need a business-oriented perspective. Entrepreneurs often react emotionally during the sale process. No matter which adviser you hire, you’re the one who makes the final decisions during an acquisition.
3) Take care of the tax matters. Set up a personal holding company that acts as the parent company of the operating company(ies). In the case of an acquisition involving multiple shareholders, set up a joint acquisition LLC, with the owners’ personal holding companies above it. This company can then form a corporate income tax unit with the operating company, allowing profits and losses (including interest expenses) to be offset against each other.
4) Search for and find the right businesses. The market for business acquisitions is far from transparent. Therefore, use as many sources of information as possible: online profiles, your personal network, and reach out to advisers. Don’t hesitate to approach businesses that aren’t for sale. Ultimately, virtually every business is for sale. Treat your first contact with a seller (or their adviser) purely as an initial introduction. Don’t mention any figures, don’t criticize the business, and don’t jump straight into negotiations.
5) Evaluate the business. Conduct a thorough, comprehensive investigation of the acquisition target. Examine the business itself, the market, the products, the staff, the operations, the customers and suppliers, and the reason for the sale. After your research, draw up a comprehensive questionnaire for the seller. Ask follow-up questions; don’t settle for evasive answers. Compare the latest annual figures not only with the business’s historical figures but also with those of similar businesses in the industry. This will help you identify discrepancies more quickly.
6) Determine the value of the business. When valuing businesses, there are roughly two approaches: the accounting approach (such as rules of thumb) and an economic approach (such as the DCF method). Keep in mind, however, that ultimately only one number matters: not the value, but the price you pay for the business. Not only does the perception of value play a role here, but so does the buyer’s ability to finance the purchase.
7) Negotiating the deal. It goes without saying that you shouldn’t just jump into negotiations. You need to establish your position on a number of issues, namely: set your limits, define your objectives, determine your negotiation style, and decide on your tactics.
8) Dive deeper into the business. In this phase, you turn the business inside out. After all, maybe the numbers were polished up after they rolled out of the system? Maybe there really is a risk of a back tax assessment from the tax authorities? To get answers to all these questions, you conduct due diligence, also known as an audit.
9) Arranging financing. You need money to close the deal. These days, you have to structure your financing to cover the total acquisition price by using various sources of funding, such as equity, bank loans, vendor loans, investors, government programs, and alternative options. Be well-prepared when meeting with each financier.
10) Pop the champagne. This step-by-step guide consists of 9 steps, but we don’t want to leave out step 10: signing the purchase agreement and popping the champagne. Congratulations—you’re the owner of the business!
How do you finance a management buy-in?
Bank financing is still available to MBIs, but you can no longer secure it based on just two A4 pages and an old set of financial statements. Years ago, a business acquisition worth several million could, so to speak, be financed with 150,000 euros in equity from a home. Simply because the bank was willing to bridge the remaining gap—sometimes as much as 80 to 90 percent. But those days are over. Currently, banks are willing to finance a maximum of 50% of the total acquisition price. The other half will therefore have to come from the buyer’s own funds and other sources of financing.
In practice, this means a mix of funding sources is needed—sometimes referred to as “stacked” or “pizza” financing—to complete the overall financing picture. Nevertheless, a bank is involved in almost all acquisitions, as it remains the cheapest way to raise capital.
These are the most common ways to finance an MBI:
Equity
First and foremost, you can’t avoid putting your own capital on the line. Because it’s very simple: if you aren’t willing to take risks yourself, why would a bank or other financiers be willing to do so? Banks, as well as investors, want you to demonstrate your commitment. They want you to feel the pain if things go wrong, because only then will you do everything in your power to make the acquired business a success. After all, a buyer who doesn’t commit financially might easily be tempted to accept a nice salaried job and say goodbye to their business.
The amount of the buyer’s own contribution is relative. A buyer who scrapes together 100,000 using all their savings, the equity in their home, and the proceeds from selling their shares—and is willing to commit all of it—is putting more on the line than a buyer who has a million in their bank account but only wants to invest 100,000. No bank will want to completely drain a buyer’s funds, but a buyer will have to commit a significant portion of their assets. The main sources of the down payment are savings accounts, stock portfolios, and the equity in one’s home.
Bank loan
Most buyers won’t be able to manage with their own capital alone, so you’ll need to look for other sources of funding. The most obvious way to finance the deal is through a bank loan. A major advantage of a bank—compared to an investor—is that you retain full ownership of the shares and therefore don’t give up any control. Moreover, a bank loan is cheaper than capital from an investment firm, which demands much higher returns.
Vendor loan
In many cases, equity and a bank loan are not enough to finance the entire purchase price. Often, the seller provides a solution by extending a so-called vendor loan. Under this arrangement, a portion of the purchase price remains outstanding and is converted into a loan. This loan is usually subordinated to the bank financing.
Investors
Another important category of capital providers are investors. Unlike financiers, they do not provide loan capital, but rather equity capital and subordinated loans. They become co-shareholders, which is why many buyers deal with investors only when there really is no other way. Investors, by the way, offer more than just money. Often they have a large network and knowledge of the market, from which the entrepreneur can benefit. The most important investors in SMEs are private equity firms and informal investors.
Alternative sources of financing
Due to stricter selection at the gate by banks, more and more financing alternatives have recently emerged. Although still in limited use for acquisition financing, these are the three most important emerging sources of financing: crowdfunding, credit unions and the private exchange.
What are the biggest pitfalls of a management buy-in?
Taking over a business via a management buy-in is complex and not without risk. Here are the 11 biggest pitfalls in a management buy-in:
#1 No clear buyer profile
Many people looking for businesses do not have a clear profile of what they are looking for. If you don't know what you are looking for, you will never find it. In addition, you can't expect an intermediary, bank or accountant to seriously help you if you don't know exactly what you want.
#2 Business too dependent on incumbent owner
One of the most important questions you need to find out: how decisive is the incumbent owner for the success of the company? Because it can all look great, but if the owner basically does everything alone, all the customers are tied to him, he is a leading figure within the world in which the business operates, then the business is extremely susceptible to a changing of the guard. Don't underestimate that.
#3 Underestimating financing
It’s best to start assessing your financial options early on and carefully determine how much risk you’re willing to take when acquiring a business. Buying a business without contributing your own funds is a pipe dream.
#4 Falling in Love with a Business
A common pitfall, especially for first-time buyers, is that they “fall in love” with a business. They’re completely sold on the business, think the seller is a nice guy, and—because they’re so smitten—are blind to the business’s weaknesses. As a result, they tend to give away too much during negotiations.
They’re too quick to believe that no customers will walk away and that revenue will really be as high as the seller claims. By this point, negotiations are already well underway, making it difficult to pull the plug—both mentally and because of the costs already incurred. At such a moment, the buyer’s position is weak. He will be more willing to bridge that final gap between the asking price and the offer price, pushing the purchase price to the very edge of what is commercially justifiable.
#5 Conduct your own negotiations
It’s wise not to conduct the negotiations yourself. An adviser isn’t emotionally involved and has the advantage of not straining your relationship with the seller. The negotiator is the bad guy; you’re the good guy. Any harsh criticism of the business falls on your adviser, not on you.
Most transactions fall through not because of the numbers, but because of a lack of chemistry. Emotions play a major role in the acquisition process, especially when the seller is a controlling shareholder selling his “baby.”
#6 Winner's curse
If there are multiple bidders in the running, there is a risk of the “winner’s curse.” The buyer must and will acquire the business and makes an offer without considering whether it is still proportionate to the business’s value. Some highly sought-after businesses are sold through an auction. It is precisely in such situations that the risk of the winner’s curse is at its highest. Incidentally, as an MBI candidate, you don’t stand a chance at an auction. These types of businesses are sold to large strategic buyers.
#7 Anchoring
Another pitfall is anchoring: getting “anchored” to the asking price. If you use the asking price as your starting point, you might end up paying more than is reasonable. If the asking price is one million euros and you end up paying 800,000 euros, have you gotten a good deal? Yes, relative to the asking price—but not if, according to your own projections, it will take eight years to recoup the purchase price. Therefore, never use the asking price as your starting point—always use your own valuation instead.
#8 Too much knowledge
It may sound strange, but too much knowledge can also work against you. We'll assume for a moment that the seller hasn't put down an asking price; he'll let you come up with an offer. You have made a resounding business valuation based on an ambitious business plan and the DCF method, arrive at a value of one million euros and then make an offer of seven tons.
The seller, a baby boomer who knows absolutely nothing about these kinds of modern valuation techniques, relied on a rule of thumb, looked only at the past few years, and had a price of five hundred thousand in mind. In this case, your knowledge works against you. The seller will eagerly accept your offer.
#9 Lack of personal contact
A pitfall that cannot be emphasized enough is an over-focus on numbers. Keep working on a good relationship with the seller. Keep talking to each other; it is crippling to the process if you don't hear anything for weeks. Suggest having dinner together, possibly with partners present, to make the contact more pleasant and take it out of the negotiating sphere.
#10 Sow confusion
Sometimes, parties deliberately create confusion during negotiations as a tactic to gain an advantage. Is the discussion about the total purchase price of the shares, or just about the goodwill? If the buyer repays the company’s current account debt to the seller’s holding company, is that part of the purchase price or not? Are the parties discussing the legal transaction date (when the shares are actually transferred) or the economic transaction date (the date from which the company’s results belong to the buyer)?
In practice, it’s common for such misunderstandings to result in differences of hundreds of thousands of euros in perceived acquisition prices. Especially if they persist into the later stages, these misunderstandings can lead to significant friction and even cause the deal to fall through.
#11 Implementing changes too quickly
Once you’ve bought the business, caution is key. Don’t go in like a bull in a china shop and alienate the staff. The good employees will leave quickly, and you’ll be left with a weakened business that could soon run into trouble.
Frequently Asked Questions About Management Buy-Ins (MBI)
What is a management buy-in (MBI)?
A management buy-in is the acquisition of an existing business by an outside manager who wants to become an entrepreneur rather than start a business from scratch. The existing business already brings with it revenue, customers, suppliers, and staff.
How long does a management buy-in process take, on average?
An acquisition process takes an average of one to one and a half years, from the initial exploration to the signing of the purchase agreement.
How much of your own capital do you need for a management buy-in?
Banks currently typically finance up to 50% of the total acquisition price, which means that as a buyer, you’ll need to account for at least half of the funds coming from your own resources and additional sources of financing, such as a vendor loan or investors.
What are the biggest pitfalls of a management buy-in?
Common pitfalls include an unclear buyer profile, a business that is too dependent on the current owner, underestimating the financing requirements, “falling in love” with a business, and the “winner’s curse” in a bidding war with multiple interested parties.
Why is it recommended not to conduct the negotiations yourself?
An adviser isn’t emotionally involved and can take on the role of the “bad guy,” so that criticism of the business doesn’t strain your relationship with the seller. Many deals fall through not because of the numbers, but because of a lack of chemistry between the buyer and the seller.
