What is management buyout and how does it work?

A management buyout or MBO is a transaction, in which, the management team of the company purchases the assets & operations of the business they manage. The management switches from being employees of the business to the owners and enjoy the benefits of the same. The main reason for a management buyout (MBO) is that a company can go private in an effort to streamline operations and improve profitability.  

MBOs are the preferred exit strategy for large organisations that wish to pursue the sale of divisions that are not part of their core business, or by private businesses, where the owner wishes to retire and cash out. Even then, they are more common in industries where the senior management/employees are critical. For example, companies in the pharmaceuticals, software, or any other research-based industry. Since the top executives of these companies are very important, MBOs are ideal for these organisations and are preferred as compared to selling the stake to outsiders.

MBOs are largely viewed favourably by hedge funds and large financiers, who have a stake in the company. These entities encourage the company to go private so that it can streamline its operations, improve profitability and consequently, go public at a much higher valuation down the road.   

The financing required for an MBO is usually a combination of debt & equity and can be quite substantial. It is funded through management contribution, asset finance, bank debt, private equity, etc. So, while the management can reap the rewards of ownership after an MBO, this comes with significantly more responsibility and a far greater potential for loss. The transition from being employees to owners also requires a change in the mindset from managerial to entrepreneurial and hence, it is not easy for managers to be successful in making the transition.