Management Buyout – Top 5 things to consider
1. What is a Management Buyout (MBO)?
A management buyout is a financial transaction in which a member of the management team purchases the company from its registered owner. MBO’s usually occur in private companies in an effort to enhance profitability and simplify strategies. They are funded using a combination of private equity investors and personal finances. Upon completion of a MBO, the management team will acquire all or part of the company they manage. More often than not, the management team assumes total responsibility for the business and uses their knowledge to develop and advance the company.
2. Benefits of an MBO
No need to market the business
In an MBO there is no need to market the business in order to find a buyer. This makes the sale quicker and easier than a trade sale; the managers will already know the business and what they are buying. Therefore, due diligence should proceed far faster than that of a trade sale.
Opportunity for managers
Managers will be drawn to an MBO because it offers them an opportunity to gain greater incentives and influence over the business. By purchasing a controlling interest in the company, the managers not only significantly increase their future earning-potential but also have the chance to help the company achieve long-term success.
Maintain confidentiality
When selling to the management team, confidentiality surrounding the sale can be maintained to a higher standard. This helps prevent the disclosure of potentially sensitive information to other third parties. It also assists in preserving the trust of employees, suppliers, and customers in the company. Even with a written non-disclosure agreement, there is a greater chance of sensitive information being leaked in a trade sale.
Immediate success
Because the seller is not dependent on a third party who is inexperienced with the business, there are less likely to be challenges when selling to management. The senior management team will be well-versed with the company’s operations, history, clientele, personnel, and culture. This facilitates a smooth transition and gives the company the best opportunity for immediate performance and continuity. Selling to internal management rather than external buyers will also give the seller confidence that the company will be left in ‘good hands’.
3. Drawbacks
Market value and limited growth
It is rare that an MBO is self-funded by the management team. This is because the management team are unlikely to have the sufficient funds to cover the business’s valuation. In contrast to a trade sale, the seller may not receive the market value of the business that they hoped for. It is also highly likely that there will be some deferred consideration since the buyer/s will need to seek out additional funding from a lender, such as a bank. Deferred consideration means that the business will effectively take on a debt and make repayments. The management team must take this into account as it will affect the cashflow of the business whilst repayments are being made. Having limited cash flow may restrict the company’s ability to grow and adapt to changing market conditions.
Conflicts
Relationships between the management team and the seller may deteriorate if the MBO is unsuccessful. This puts the future of the business at risk as it can negatively impact how the company is managed going forward.
Furthermore, the management team become the owners of the company whilst also remaining as employees. This raises the question of potential conflicts of interest as the managers will take on two roles; firstly they become an owner of the company with an interest in its profits and secondly they remain employed. The management team may experience conflicting interests in their two roles. For instance, they might put their own interests ahead of the needs of the business.
Lack of skills
The management team will be sufficiently knowledgeable in the area of the business that they specialise. However, becoming an owner of a business requires a different set of skills. The management team may struggle to adjust to the competencies required as a stakeholder of the business.
4. Key documentation
There are several financial and legal phases involved in an MBO. Firstly establishing an agreement with the shareholders, then securing financing for the buyer/s, as well as completing the transaction. During these phases, there are certain documents that are essential to the transaction. These include but are not limited to:
Non-disclosure Agreement – to ensure confidential information about the business is kept secret.
Heads of Terms – establishing the terms on which the parties are ready to move forward with the deal.
Exclusivity Agreement – giving the management team time to prepare for the transaction and preventing the seller from seeking a trade sale as a result of impatience.
Asset/Share Purchase Agreement – an agreement which is used to transfer and assign the ownership of the assets or shares.
Disclosure letter – creating an opportunity for the seller to disclose to the management team any issues with the business that may be contradictory with the warranties.
Tax Deed or Covenant – protecting the buyer/s against any tax liabilities which may arise when they take over the responsibility of the company.
Articles of Association and Shareholders Agreement – governing how the company will run post-completion.
Finance documents – contracts and agreements relating to the finances, such as an investment agreement, security documents and a facility agreement from the funder.
Transfer of Intellectual Property and Contracts – ensuring legal title of IP passes to the management team and that contracts with the company are assigned.
Employment Contracts – directors service contracts outlining the terms and conditions of employment.
Director Guarantees – additional personal security taken on part of the directors in relation to the company debts.
Companies House Filings – facilitating and evidencing the changes to the structure of the company.
Stock Transfer Forms – transferring legal title of the shares.
Legal Charges – relating to the property owned or leased by the company.
5. Is an MBO the best option?
A seller must weigh the benefits against the drawbacks of an MBO and compare these to other corporate transactions. Ultimately, the seller should choose the best transaction based on the circumstances surrounding the company as well as their individual needs.
If you are looking to sell your company and seek advice to which financial transaction would be most appropriate to fit your requirements, please contact a member of the corporate team at Clarkslegal. Our experienced corporate advisors will be able to provide you with advice that is specifically tailored to your situation.