MBOs: The goldmine opportunity

A great deal has been written about Management Buy Outs (MBOs) since the 1980s. They’re very well understood transaction types that shift majority control of a company from the current owners to the senior management within a company.

By volume, most are small businesses backed with some combination of bank and vendor debt. They’re easy to put together, fund, and are more likely to give all sides a positive experience compared to a trade sale. Private Equity can get involved at the ‘mid market’ level (£10m cheques or more these days) and, at a personal level, these are the deals I enjoy most. However, conceptually, MBOs are generally straight forward – We have a guide as to how to put them together. But there is something missing in everyone’s commentary and analysis; zooming out from the individual transaction there is an opportunity of significant economic magnitude that gets no attention.

Simply, an MBO for an independent, UK mid-sized limited company (let’s say that is between £5m and £250m of revenue to keep that definition broad. Selling to an MBO team is vastly more beneficial to the UK economy, tax man and society than the typical trade sale. There is a simple reason for this, that is obvious, but never said – when anyone rational buys a Company, the new shareholders and their ultimate financial backers must create more long term economic value from the combination of distributed income (dividends, interest payments etc) and capital value (the value of the shares) than the sellers capture in the price – this is lost in the UK’s quite basic approach to free trade which, at times, can be so “free” that we can allow these ultimate benefits to flow to countries that house serial acquirers and financial sponsors with scale. In other words, it’s so easy to buy a UK company that we do at times seem to invite Companies in other nations to mop up our best or highest potential assets, because the buyer normally always wins in the long run.

There are consequences to this.

• 1.  HMRC gets the bunce of the sale tax proceeds, but then loses out on the tax proceeds of all the income that flows to the home nation of the ultimate buyers, and a bigger capital tax receipt if the company then sells later down the line after growing.
• 2. It sends the message to the next generation of management in the UK that creating value means shifting the focus of control abroad – we culturally accept the UK is not the master of its own destiny as bigger buyers will ultimately have an international presence.
• 3. It undermines the quality of the UK.

We love international deals and are not saying they should be avoided or are inherently a poor choice. Instead, the point is that keeping the great and the good in the hands of UK shareholders and financial sponsors for longer creates value and the most obvious mechanism to achieve this, if the current shareholders want to ‘exit’, is an MBO.

What could that look like in terms of benefit?

At our last check in early May 2024, there were 17,274 companies that fit the definition of mid-sized above. These are independent companies with some size that have not been bought or sold recently. Each of them could be an MBO candidate.

In aggregate these companies have:

• 1. £557bn of revenue (that’s about double Apple’s and about the same as Walmart)
• 2. £48bn of EBITDA (which is about 4.5x Tesla’s or 1.7x Walmart)
• 3. Crudely, if these businesses were valued at 6x EBITDA then the aggregate Enterprise Value would be around £289bn (about 10x less than Apple’s market cap, half of Tesla, half of Walmart and anyone who studies valuation will know that market cap is quoted at a discount to Enterprise Value) – to find out more about multiples check out our valuation webinars. 6x is crude but given the distribution of companies in the sample, not wildly out for the UK today. This means the average business is worth around £16m today.
• 4. Employ 3.2m people (which is about 50% than the UK’s largest employer, the NHS)

In aggregate, these businesses are incredibly powerful, have enormous potential and are undervalued relative to US peers. Time to invest in them to grow value and profits, right? Obvious, isn’t it? Stimulus to grow these companies will create more opportunities to employ people at the cutting edge of a global landscape, and more tax revenue for HMRC. Perhaps one route to stimulus is shifting who owns these businesses to their UK based management teams to keep the flows of economic and social benefit for longer.

MBO teams normally consist of a team of three and, often, this teams includes younger prospective shareholders than the current owners who are heavily incentivised to grow as they’ve just bought a business levered with debt at record high interest rates in recent economic cycles. Increasingly many of the people in this new ownership cohort are millennials. The core team is normally a mix of a potential MD, FD and Chair with a second-tier team not far behind them covering sales and operations who will also have some form of incentive. This means there are 51,882 potential core team MBO candidates out there in these Companies.

Now for the fun part – what could this be worth to those that take the risk to buy, and to the UK tax authorities? After all, there is a tax gap to fill.

Most MBO teams aim to grow profits and or value at a rate that is around 15% to 20% per year for the first 5 years where, typically, the fastest gains can be made from evolving the management and growth strategy of a business by a team who know it well (note that with PE stimulus these growth rates can be higher and faster). But for experiment’s sake, let’s say the MBO team don’t go down the PE route and fail to deliver change at the desired pace – let’s say they deliver around 7.5% growth over 15 years, which is a decent slug of anyone’s career – those businesses should have repaid their debts long before the end of that 15 year term and would have grown from being worth £16m each to £50m each.

At that point, if these businesses sell, the MBO team are on for around £11m each pre-tax which is a life changing sum to hand to 51,882 UK individuals – an entire generation can be incentivised on a purely meritocratic basis where it doesn’t matter where they went to school or who their parents were. All that matters is how good they are at running a business and competing.

From a tax revenue perspective, HMRC lock into:

• 1. The capital tax proceeds on sale to the MBO team
• 2. The higher tax receipts from the growing companies
• 3. The capital tax proceeds from the second sale

In total that is a number far in excess of £161bn over 15 years, or £10.7bn a year on average excluding the company level taxes for the premium growth rate that an MBO team normally deliver compared to current owners.

For reference, the difference between tax receipts and government expenditure in 2023 was £130bn. Assuming that this gap continues (let’s be honest, it might widen!), we think that MBOs could be a powerful way to help close that gap which leads to net borrowing. Meanwhile, the wider benefits to society and the feeling of what it means to be part of a UK business community that doesn’t need to sell abroad to get the pay day, could bring an intangible benefit that is far more valuable – empowering those exceptional people to take risk (MBO team’s need ‘skin in the game’ – 1980s language for a 1980s transaction model) and create value for themselves and society as a whole isn’t novel but it is untapped.