A company can be purchased in a variety of ways and for a variety of reasons. One of the most beneficial to the business is often a management buyout or "MBO" as it can ensure continuity for the business.
In this case, the current management team will purchase the company from the existing shareholders.
There are several steps, both legal and financial, that must be followed to make the buyout a success.
The process for a management buyout typically begins with an agreement between the current management team and the shareholders of the company.
The managers will need to demonstrate to the shareholders that they have both the expertise and financial resources needed to successfully purchase the business.
What is a management buyout?
A management buyout, or MBO, is a type of transaction in which the current management team of a company, purchases the assets and ownership interests of the company from its shareholders.
This process involves several legal and financial steps, including negotiating an agreement with the shareholders, securing financing for the purchase, and finalising the transaction through various legal processes.
Here are some of the key legal considerations for management buyouts:
The management team must perform due diligence, which can cover financial, commercial and legal concerns, so it's critical that the process is carefully considered, especially in areas where the MBO team does not have full understanding, for example, the nature of any existing contracts and agreements.
While the MBO team may have played a key role in the business, they may not be aware of all areas involved and any financial issues that could affect the future of the business.
This process helps the management team get a full understanding of the company's operations, from a detailed financial analysis to the nature of contracts with all the employees and partners.
Once the due diligence is finished, the legal paperwork such as warranties will generally be negotiated.
The existing management team should insist that the right warranties are in place in order to protect them against future liabilities. This makes the sellers of the business liable collectively and individually should anything arise in future.
Management teams rarely have involvement in what is happening at "group" level, for example on issues such as; insurance, tax, property, intellectual property or the pensions aspects of the business. The management team should seek full warranty cover in relation to these matters.
If the management team is required to give warranties during the MBO process, full consideration should be given to their scope and any time or financial limits on claims that can be brought.
Legal documents and contracts
The following is a breakdown of some of the legal contracts required during the management buyout process:
Asset Purchase / Share Agreement
An asset purchase is when the management team takes on select assets and rights and sometimes even takes responsibility for certain liabilities relating to the target business.
A share purchase involves buying company's shares.
A Tax Deed or Covenant
This is used to guarantee that the selling shareholders are responsible for any pre-completion (or pre-accounts date) tax.
Bank finance documentation
This ensures any agreements with the bank and private equity investors are binding and your interests are protected.
Contracts of employment and any service agreements for the directors to ensure the company's success continues.
A shareholders agreement
This shareholders' agreement regulates the company's leadership, ownership of shares and shareholder protection. They also govern the company's management along with the articles of association.
Completion of an MBO
Will the exchange and completion take place at the same time or will there be a delay between them? This is often dependent on any consents that need to be obtained (for example, from a landlord) or conditions imposed by a lender that need to be satisfied. All relevant documents will be signed and the acquisition of the target company (or its assets) will take place.
The key steps for management buyouts
- Ensure the MBO team are committed and have clear reasons as to why they want to buy the business out.
- Understand the reasons for sellers wanting to sell.
- Make a thorough assessment of the company's financials, market, services, people, and growth prospects.
- Understand the tax consequences of the MBO.
- Establish the management buyout funding source and financial partners.
- Due diligence.
- Drafting of any legal letters and contracts.
What are the advantages of a management buyout?
One of the main advantages of a management buyout is that it can help to keep the company's current management team in place.
The management team pools resources and allows the company to continue operating with little disruption, which can help to maintain or even improve its value.
Additionally, an MBO may result in more favourable terms for the existing shareholders, as they may receive compensation for selling their shares. This type of transaction also allows managers to retain any future profits and growth opportunities resulting from the purchase.
If you are interested in pursuing a management buyout, it is important to work with experienced legal professionals who can guide you through each step of the process and help ensure its success. With their assistance, you can successfully navigate all legal and financial requirements.
How do you fund a management buyout?
There are a few different ways to finance a management buyout including personal savings, taking out loans, or securing financing from investors.
Another possibility is to use the company's existing cash flow or assets as collateral for a loan.
In some cases, the managers may also be able to negotiate favourable terms with the shareholders, such as an earn-out provision that allows them to pay for the shares over time based on the future performance of the company.
Other ways to fund management buyouts include:
It's possible that the management of a business lacks the financial resources to purchase the company on its own.
One of the most common alternatives is to borrow money from a bank.
Banks, on the other hand, may be wary of buyouts by management teams, because they consider them too hazardous, making it less likely they will take this risk.
This is funding that allows companies to leverage against their assets, such as real estate, stocks, or debtors, and it can be a viable alternative for asset-rich businesses looking at management buyouts.
Private Equity (or PE)
Private equity funds can often be used to support excellent management teams. If the prospect for growth, underlying earnings, team and company are good, an MBO using Private Equity may be feasible.
Private equity funds are another type of external funding that can provide various services in addition to cash to assist a management team, fill holes, and grow the company.
Vendor loan notes
Often, the sellers will assist in the transition, leaving some of their consideration in the business as loan notes to be repaid over time. This can ensure continuity of the CORE business, and can provide a seamless transition for employees and customers.
The tax implications of a management buyout
The tax implications of a management buyout will vary depending on the specific details and circumstances of the transaction. It is important to work with experienced tax professionals to ensure that you are aware of all applicable taxes and how they will apply to your situation.
Some of the potential taxes that may be applicable to a management buyout include:
- Capital gains tax, which can be applied to the difference between the sale price of the shares and their original purchase price.
- Value added tax (VAT).
- Stamp duty, on any agreement related to the transaction.
- Corporation tax.
There are some key variables when it comes to taxation and MBOs:
- Is the planned MBO a share or asset purchase?
- Is it required that a new company be formed for the purpose of the acquisition?
- An analysis of any potential income tax liabilities for management.
- Are there any more restructuring requirements in the MBO that should be considered?
- Is there a vendor earn-out period?
- Who is receiving the money – the company or individual purchasers?
- Is external finance available and who will get it: the company or its clients?
- What are the anticipated future exit possibilities for the purchasing management team to ensure they aren't responsible for income tax?
Valuation and structure of an MBO
The valuation will work the same way as it would if buying any other UK company. The market is one of the key drivers of price.
The valuation of the business and structure of the MBO may also depend on the following factors:
- An overview of the company's future business plan and forecast is required
- A thorough knowledge of the company's financials, including working capital, profit, cash and debt
- Up to date, asset valuations of any equipment intended to be used in asset finance arrangements
- Any discounts that may need to be relevant
- The company's ability to service its existing debt, if any more debt is expected to be used as a source of cash flow, and anything else that might influence the firm's long-term growth.
When is a management buyout necessary?
A management buyout is not always the best option for a company. There are a few key indicators that will help you determine whether or not an MBO is the right move for the business:
- The current owners are looking to exit the business.
- The management team is motivated to grow the company.
- The company has an excellent team and strong growth potential.
- There are gaps in the management team that need to be filled.
- The company is struggling financially, but has good underlying assets or a unique offering.
If your company meets these criteria, it may be time to consider an MBO and the right legal advice can ensure the process runs smoothly.
The difference between an MBO and an MBI (management buy in)
Management buyouts (MBOs) and Management Buyins (MBIs) are similar with a key distinction being that with an MBO, the management team tends to remain, and with an MBI, a change of ownership can occur resulting in a replacement of the management team or a significant addition to the management team.
What is a leveraged buyout?
A leveraged buyout (LBO) is a type of acquisition in which a firm is purchased with a mix of debt and equity, with the company's cash flow serving as the collateral to secure and repay the loan. A management buyout (MBO) is an instance of an LBO, when current management buys a company from its existing owners.
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