Key Stages of Privatisation

3. Methods of Sale

b) Management/Employee Buy-Out (MBO/MEBO)

i) Competitive

A competitive MBO/MEBO is basically a trade sale in which one of the bidders is a team of the enterprise’s current management, or the management together with the other employees. They will probably have financial backing from an external investor as they are unlikely to have enough capital themselves to be able to buy the enterprise.

The vendor may want to encourage the management and/or employees to bid for the enterprise, as it will show potential external investors that it is worth acquiring, and thus stimulate competition between them, and it will also keep the management and employees well motivated in the period leading up to the sale. They may also see benefits in selling the enterprise to its own employees as they have experience and expertise in the field, and have a stake themselves in the success of the enterprise, in that their jobs depend on it. However, the management know more about the enterprise than anyone else, and there is a danger that their involvement will deter external investors if they are considered to have an unfair advantage. The vendor should therefore apply special safeguards to prevent this.

The process of a competitive MBO is very similar to that of a trade sale. The same guidelines which apply to a trade sale apply here, though there are a few extra issues the vendor needs to consider with regard to this process.

Managing any conflicts of interest

The vendor should consider excluding from the decision making process management and/or employees who are directly or indirectly involved in the management buy-out team. They might also issue a code of conduct for management buy-out teams which require them to register their interest, and specify what information they can give to their financial backers, and may also consider appointing one or more independent directors to the managing board of the enterprise to ensure that all procedures are followed properly if there are any conflicts of interest for the management themselves.

The vendor should ensure that the same amount of information is made available to all bidders in the process, and that people on the MBO team are not allowed to abuse the internal information they have. Representatives or agents of the vendor should be present at all meetings between the management and the bidders to ensure that information is made available on an equal basis to all the bidders.

In some cases the vendor has decided not to allow the management or employees to be involved in a bid for the enterprise until a preferred external bidder has been identified, at which point the preferred bidder and the management/employees are allowed to enter into negotiations.

When the vendor wants the management/employees to bid for an enterprise they sometimes offer incentives to encourage them. Incentives may take the form of assistance with the costs of mounting a bid, or the vendor may decide to give preference to the management bid if it is within a certain percentage of the highest bid, and satisfactory in all other respects.

If they do offer incentives to the management/employees they should take care that they are not so great as to risk loss of value in the sale. Any privileges granted to the management/employees should also be made known to the other bidders, and if possible to the general public, otherwise they may lose confidence in the integrity of the process.

If the MBO team secure financial or commercial backing from another source the vendor may consider withdrawing from them any financial support they had previously offered.

The vendor should take steps to ensure that the management cannot buy the enterprise for a very low price and on very good terms, and then some time later sell it on themselves for considerable profit.

One way of preventing this eventuality is by instigating a fully competitive sale process, and even if there is not much interest from investors the vendor should refuse to sell the enterprise to the management/employees for any less than the floor price.

If the vendor fears that the price of the enterprise may rise significantly after it is privatized and that a successful MBO team may and try and sell it on for their own profit, they would be well advised to insist on a clawback clause in the contract (see Part One 3 (a) i) above), in order to secure a proportion of the money from such an eventuality.

Evaluation of co-investors

Co-investors are the group from whom the MBO team gets financial backing for their bid. They are likely to provide their money through private equity funds or venture capital funds.

The vendor should investigate the co-investors to ensure that they may not present a risk to the enterprise in the future.

Firstly the vendor should ascertain how long they intend to provide investment for the enterprise for. Many such funds may be interested only in investing their money for a period of a few years, and if they pull out then the privatized company may be left bankrupt, as very seldom will the MBO team have enough capital of their own to sustain the business. Thus the vendor should seek assurance from the co-investors that they intend to keep their investment in the company for a specified (preferably long) period of time.

If the enterprise is of strategic importance then the government may have concerns about it being wholly financed by a foreign investor. The vendor may wish to investigate where the investors are based and what other assets they own or finance.

ii) Non-competitive

There have been occasions in which a vendor has offered the enterprise to its own management and/or employees without competition, though this has been relatively rare. This might happen if the Government desperately wants to privatize an enterprise but can find no external buyers, or if the government expressly wants the ownership of the enterprise to go to its own employees.

Although the process is not competitive, the vendor should still consult some external advisors, above all for a valuation of the enterprise, and may still wish to make some reforms to the enterprise before selling it. In these ways it is similar to a trade sale, but it does not include the marketing stage. However, the vendor may still wish to obtain a good price for the enterprise, in accordance with the independent valuation.

Setting the price

Due to the fact that there is no competition it seems unlikely that the management/employee buyers will offer any more money than the lowest amount the vendor is prepared to accept. Hence the vendor will probably name their price and wait to see if the buyers will accept it.

The vendor may initially ask a price which is higher than the floor price which they should have decided on after the valuation. If the buyers will not accept this price then the vendor may be prepared to drop their demand as low as the floor price. If the buyers still refuse, even at the floor price, then the vendor has few choices left. They may eventually decide to capitulate and accept the low price offered by the buyers, but in this situation the vendor and the Government must ask if it is wise to privatize the enterprise at all at this point.

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