When looking to exit a business, an individual or business owner has several options to pursue, one of which is to sell the company to the existing management team, otherwise referred to as management buyout.
While this may be a preferred option by many, as it allows the business to carry on independently in what is believed to be safe hands, it can also be a gruelling process that places significant pressure on management teams and those around them.
With years of experience navigating cases within this area, we’ve put together this blog to answer any question you may have about what a management buyout is.
How does a management buyout work?
As mentioned above, a management buyout (MBO) involves selling the business to the management team of a company. The management team will combine the necessary resources to acquire all or part of the company they manage, however, predominantly, they will take full control and ownership.
Once the business is acquired, the management team will be responsible for taking the business forwards, supporting its growth.
It is also an option for a larger company to sell a division of the business that is no longer part of its core services.
The management buyout model
Generally speaking, the process is as follows:
Both the buyer(s) and seller agree on a sale price. This may include an independent valuation.
The management team determine the amount they are currently able to invest.
A detailed financial analysis is conducted. This includes building a forecast financial model to reflect the serviceability of debt and returns to potential investors.
An approach to funders is made - small buyouts may involve just one funder, while larger transactions may require several funders to handle the financing.
Additionally, a crucial part of the process is the management buyout agreement, and you will need a solicitor to assist you with this.
The entire process from start to finish can take around 6 months, which is roughly the same as a trade sale. Therefore, both the vendors and the management team must be fully committed to the transaction for the duration of that timeframe.
What are the advantages and disadvantages of a management buyout?
The MBO process can offer great advantages to all involved. Perhaps the most obvious benefit is the smooth transition from one owner to another, reducing the risk of failure. This is because the new owners already know the company, employees are less likely to be concerned and existing clients can be reassured they are receiving their services as normal.
Furthermore, all internal changes and transfers between the vendors and the management team remain confidential, with any due diligence being handled quickly and effectively.
The disadvantage, however, is that it can be complicated and time-consuming to carry out yourself, especially when you are trying to run a business or manage a team. Luckily, solicitors are well-trained in this area and are equipped with the necessary knowledge to ensure all goes smoothly from start to finish.
Management buyout funding options
In order for an MBO to be completely successful, a vendor must be willing to sell the business at a realistic price. In most cases it is rare to see a management team with enough funds to buy the company, therefore external finances are generally required. This can include a combination of sources, such as:
Management contribution – the management team is required to introduce personal funds. The rule of thumb is at least one year's salary.
Asset finance – leveraging against other assets in the company such as property or stocks.
Bank debt – banks can provide a cash flow term loan, commonly repayable over 3-5 years.
Private Equity (PE) – these funds look to back the management team in a bid to scale the company.
If the above fails or is not suitable, then vendor loan notes can be used to help fund the transaction, which involves the vendor themselves helping towards the funding and leaving their consideration in the company as loan notes to be repaid over time.
Management buyout tax implications
While an MBO is one of the most commonly encountered private equity-backed transactions and are seen as a relatively low-risk investment option, MBO’s can still pose tax implications for each of the parties involved.
With so many elements to consider, tax implications often fall to the bottom of the list, which can result in costly charges.
Additionally, funders such as VCs will want to ensure their investment is optimised and protected. To do so, it is usually structured as debt, but must keep within specific rules for tax advantage purposes – this includes Venture Capital Trust (VCTs) and Enterprise Investment Scheme (EIS) rules.
There are stringent conditions attached, and you must always be prepared to pay for corporate structures that minimise tax burdens in subsequent years, which is why it is important to seek expert tax advice early on.
Do you need help with the management buyout process?
For all your business exit needs, including navigating the management buyout process, contact the team at Smith Partnership today.
It is important to involve experienced solicitors in the process as soon as possible. We can ensure that every aspect of the MBO is managed smoothly, such as considering how the deal is structured, due diligence and funding, right through to the finalisation of the deal.