Our lawyers will advise you on the management buy-out (MBO) that you are considering for your business. We will work with you to structure the MBO whilst ensuring that your position is protected and the transaction proceeds smoothly.
What does a successful MBO need?
Management team - The management team will be the driving force behind the MBO and the key to the future success of the business. Investors will need to be convinced that the management team has the right strategy and the ability to make a success of the business.
Profitable business - The business has to be capable of operating as a profitable independent going concern with the ability to be self-financing.
The right price – As the business has to be able to generate sufficient cash to pay for the debt finance funding the transaction, this requirement, of itself, sets a limit on the price that can be paid. In addition if too much is paid neither the management team nor investors will get a return. The right price needs to be based upon a proper valuation of the business, not just in financial terms but also taking into account commercial and legal due diligence.
Finance - The management team will need to prepare a detailed business plan aimed at satisfying repayment of debt within agreed timescales. The terms upon which it is agreed will be crucial to the transaction, particularly where investors (including the management itself) are taking an equity stake. The management team may also be required to provide banking guarantees and covenants.
Governance – Clear and workable arrangements must be agreed for the relationship between the management team and the investors, and between members of the management team.
How is an MBO structured?
MBOs have varying structures to accommodate the commercial requirement of the owner, the management team and the investors. A common arrangement, however, is as follows:
- A newly established company (NewCo) is set up by the management team to buy the underlying business. NewCo may receive funds for the acquisition by equity finance (ie shares issued to the management team and equity investors) and debt finance.
- The management team continues to manage the underlying business. Equity investors may also become involved in the management.
- The owner of the underlying business often does not receive all the purchase price on completion. The owner is often paid in part from the revenue generated by the underlying business post-MBO which are sometimes linked to earn-out targets.
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NewCo obtains funds in the form of equity finance by issuing shares to the management team and outside investors. Whilst shareholders are the last to be paid out if the business is wound up, holders will be entitled to increase in the capital value of the underlying business and to profits.
Debt finance can be loans from the banks, or loan notes issued to granted individual or institutional investors. Debtors have a priority over shareholders if the business in wound up. Where debt financing is sought from a variety of lenders, the issue of which lenders will have priority to be paid will need to be considered. Debt finance providers often seek personal guarantees from the management team.
MBOs are commonly financed to some extent by the owner of the underlying business - this is called vendor financing. Vendor financing includes:
- Outstanding purchase consideration – part of the consideration for the sale of the underlying business is left outstanding to be paid in accordance with an agreed schedule.
- Share options – under which the management team buy the business in stages as and when funds become available.
- Loans by the vendor – the vendor provides a loan to NewCo for the purchase of the underlying business.
In all of these cases, the vendor should consider protections such as:
- Strict repayment terms, which can often be linked to business performance e.g. EBITDA
- Security over the underlying business assets.
What are the issues in the acquisition agreement?
We will focus on issues which are likely to be important whilst recognising that the emphasis will vary from business to business. Important issues are usually:
Purchase price - If the vendor has agreed to earn-outs, then the payment terms will have to be agreed exactly.
Warranties given by the vendor - The vendor should not need to provide warranties in relation to the business if the management team has had an active role in the business’ decision making. However, this is not always the case and a balance will need to be achieved with the requirements of the management team and investors.
Indemnities given by the vendor - The underlying business may have ongoing or future liabilities (such as tax or litigation) which may need to be covered by indemnities from the vendor.
Restrictions on the vendor - The vendor may need to be restricted as to future business ventures so that there is no competition with the business being sold.
Due diligence - Due diligence should reveal any issues that may affect the vale of the underlying business.
Will the management team be free to manage the business after completion?
The management team of the business are likely to be restricted even after completion of the sale by the requirements of investors. These are usually contained in the investment agreement. Typical provisions which need discussions are:
Board composition - A representative of the investors may be appointed as a director, often with voting rights greater than the management team.
Veto rights - Investors will usually insist on veto rights on major decisions, such as asset sales and major loans.
Transferring shares - The position on a transfer of shares by a member of the management team gives rise to issues such as:
- Will the shareholder be forced to offer the shares to the other management team members and/or investors?
- How is the sale price for the shares determined?
- Will the selling price be determined by an independent valuation?
- Will the departing shareholder be required to immediately resign as a director?
Are you thinking about an MBO?