- Helen Curtis
- Updated: Mon, 21st Nov 2016
We deliver the solutions to the management buy out team who may be dealing with an MBO for the first time and continuing to run a business. We can also act for vendors and financiers involved in MBO transactions – we offer a depth of understanding needed by any party.
Our management buy out service includes but is not limited to the following:
Structuring for the MBO
Our service will deal with the structure of the management buy out and protect your position. MBO’s are flexible in their structure and there are a variety of ways of proceeding. Often a new company is incorporated into which the business is transferred and finance provided. We refer to the new company as “NewCo”.
Equity finance vs debt finance
Equity finance is usually in the form of shares which are issued in NewCo. The disadvantage of equity finance is that shareholders are the last to be paid out if the business is wound up. Debtors have a priority over shareholders. For that reason a common form of debt finance is used, which can be loans from the banks, or loan notes granted in favour of individual or institutional investors.
The problem with debt finance for a lender is that a loan does not provide the right to capital and/or profits enjoyed by shareholders. Therefore, in practice, it is not unusual to see the management buy out structured using debt and equity to capture the best of both worlds.
Representing the MBO team
The fact that the management team is acting both as a potential purchaser of the business and its management, with different duties, is a matter which has to be carefully handled. Our service delivers the experience needed to solve the issues.
Common characteristics of a management buy out
The common characteristics of a MBO are:
- Routinely, a company is set up, a NewCo, to purchase the shares/assets of the target company and following purchase, the shares in the NewCo are held by the MBO team (and any investors). NewCo is incorporated to permit the management team to acquire debt finance for NewCo’s acquisition of the target company, if required.
- The underlying business remains the same with the existing management team remaining employed. An equity investor of NewCo may well become involved in the management of the company and where this happens this is referred to as a “BIMBO” (Buy in and Management Buy Out).
- Often the consideration the owners receive on sale is funded in whole or part from the revenue the business generates post-MBO on deferred payment terms sometimes linked to earn-out targets. We have dealt with MBOs that are funded via the use of EMI options.
Where debt financing is sought from a variety of lenders the issue becomes who will be paid off in priority to other lenders. Lenders will seek protection usually via a series of companies forming the management buy out with the most powerful lender advancing loans to the company most likely to be able to pay out.
Example of debt financing
For example, NewCo 1 will buy the target company, and a loan will be advanced to NewCo 1 from a senior lender. The repayments to the senior lender will take priority, i.e. paid first, before any repayments are made to any other providers of debt finance. The management buy out corporate documentation will seek to establish the priority and often register charges to protect the interests.
NewCo 1 will be wholly owned by NewCo 2, with NewCo 2 wholly owned by TopCo. NewCo 2 receives a loan from a secondary lender. TopCo is the company which is owned by the management team. The loan repayments from NewCo 2 to the secondary lender will rank “second” behind the repayments made by NewCo 1 to the senior lender.
Independent advice for guarantors
The providers of debt finance will often seek personal guarantees from the management team. We do advise the management team on the implications of personal guarantees and provide the independent advice many lenders require.
Representing the Seller
It is not uncommon for the management buy out to be financed by the seller, i.e. the owner of the target company. This is called vendor financing. Vendor financing can take many shapes including:
- Leaving the consideration for the shares outstanding – whilst the consideration is outstanding the vendor should consider the protections available under a shareholders’ agreement.
- Using EMI options – under which the management team buy the business in stages as and when the management team are in funds.
- Loans by the vendor to the MBO company – the vendor may provide NewCo with the funds, via a loan, for the purchase of the target company’s shares or assets.
Typical vendor finance requirements under a management buy out
We act for vendors and tell them how to protect their investment in the form of finance for the management buy out. Equally, we can act for the MBO team and put in place a workable plan.
Based on past experience, typically the vendor will look at:
- Strict repayment terms, which can often be linked to group company performance, e.g. EBITDA;
- Security for the loan, which is often taken over the MBO assets;
- A deed of subordination to ensure that their loan ranks above advances made by other creditors, e.g. secondary or senior lenders.
Cases are different because often the vendor is very familiar with the business and also there will usually be a personal relationship with the MBO team. We understand the interaction of interests and work to find a balance.
Representing the MBO team
We review documentation that has been prepared by the owners or the financiers. Our skill is to advise the MBO team on the commercial risks and their rights and obligations under the transaction. We will flag up areas where the position for the management buy out team can be improved.
We usually present the entire team but can act for individual members of the management buy out team if required.
Management buy out acquisition agreement
There are a variety of issues we will deal with for the management buy out team. The emphasis will vary from business to business. Our skill is in picking out what is likely to be important. We do understand that often the most important factor is to get the management buy out over the line – we use our skill to make that happen on the best terms securable.
Areas where we add value can include:
If the seller has agreed to earn-outs, then the payment terms will have to be strict. Between exchange and completion, the seller will usually guarantee that payments above a certain amount, or aggregate amount, will not be paid out of the target.
Warranties given by the seller to the management buy out team
Many management buy out teams will have an active role in the target company’s decision making. However, this is not always the case, as the target’s articles or any shareholders’ agreement may have limited the management team’s input. Thus, the management team will want the seller to warrant certain matters, e.g. that the target has no outstanding employment law claims , and that all intellectual property is registered and maintained. We work with the MBO team to fine tune appropriate warranties for the particular deal.
Indemnities the management buy out team should consider seeking
The target company may have ongoing or future liabilities which are in dispute. The management team needs disclosure on liabilities and consider requiring the seller to indemnify the management buy out team for these liabilities. Common liabilities are outstanding tax claims or any expected damages to be paid as a result of ongoing litigation.
We quantify the risks for the management buy out team. Often the problems are solved by capping indemnities which provide a practical solution.
Restrictions on the management buy out team
The management buy out team will want to restrict the future business ventures of the seller to compete. The seller may not want to be precluded from future business activities – this all depends upon the identity of the seller. Agreeing restrictions is a balancing exercise.
Management buy out due diligence
Our due diligence exercise can reveal any issues that could be problematic.
We take the time to understand the reason for the MBO to ensure that the acquisition agreement protects the management team’s subscription, and the target company’s future value. If the value is not protected, then the management team may find the target company unable to meet future commitments, e.g. earn out payments, or loan repayments to senior or secondary lenders.
Negotiating the management buy out investment agreement
It is common for the management team and the investors to enter into an investment agreement regulating conduct after the management buy out has been completed. The investment agreement is a private document and is not recorded at Companies House.
We can act for either the investors or the management buy out team.
Common areas to consider under an investment agreement
We are often instructed to advise the vendor, or the external financiers. Common areas to consider are as follows:
Security for loans
If acting for a vendor or external financier providing debt finance, then it is worthwhile addressing security for the debt finance. We review and advise on personal guarantees from the MBO team to protect the value in debt financing.
Management of the business
During the transitional process, the vendor will want to retain a degree of control to maximise returns where the purchase price is fixed to a future completion date. Likewise, on completion, an external financier should have in place sufficient control mechanisms within the paperwork to protect the investment provided to the MBO team.
Focus areas for regulating conduct after the management buy out has completed
It is not uncommon for private investors to insist on various protections. We will tell you what is reasonable based on our experience of previous transactions.
Typical areas where we solve concerns include:
A representative of the investors may be appointed as a director, with voting rights greater than the management team. This will have to be enshrined in the investment agreement.
The private investors will usually insist on veto rights on certain decisions, e.g. seeking debt finance or acquiring assets above a fixed value.
The investment agreement will usually cover matters relating to the transfer of shares. The position on a transfer of shares by a member of the management buy out team gives rise to issues such as:
- Will the shareholder be forced to offer their shares to the other management team members/private investors?
- How is the price received for the sale shares determined?
- Can the parties commission an independent valuation to solve any dispute as to the selling price?
- Will the departing shareholder be required to immediately resign as a director?
Pointers for a successful MBO
In our experience successful MBOs take place where there is:
A committed team
The management team is the driving force behind the MBO and the key to the success of the business going forward. Funders will need to be convinced that the management has both the right strategy and the ability to make a success of the business.
A viable business
The business has to be capable of operating as a profitable independent going concern with the ability to be self-financing. Where the business is part of a larger group, it must not be reliant on intergroup trade. In all instances it must be able to maintain commercial relationships with customers and suppliers.
The right price
As the business has to be able to generate sufficient cash itself 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 nor any equity investors will get a return. Although the right price is essentially a matter of judgment and negotiation it needs to be based upon a proper valuation of the business, not just in terms of an accounting exercise but also taking into account commercial and legal due diligence.
The management team will need to prepare a detailed business plan aimed at satisfying repayment of debt within the agreed timescales. The terms upon which it is agreed are of course crucial to the whole venture and need to be carefully negotiated, particularly where investors (including the management itself) are taking an equity stake. The MBO team may be required to provide banking guarantees and covenants which will require negotiation. We can assist on all aspects.
There is no more important document in the whole transaction than the investment agreement as it governs not only the relationship between any investors and the management team but also the relationship between the members of the team.
It is fairly common for the new MBO team to put in place equity incentives for the key staff. At the stage of planning the equity structure for NewCo a provision can be made for a pool of shares to be made available for employee share plans. We can deal with this for you.
Our track record in completing management buy outs successfully
Recent instructions include:
- Acting for the management team of an invoice financier on its MBO in conjunction with a private equity fund. We created numerous classes of shares in NewCo to ensure that the management team held shares with different rights to those shares held by the fund.
- Advising the management team of a restaurant group on its MBO, with the creation of numerous group companies for the purposes of seeking debt finance from banks.
- Preparing a post-completion investment agreement for the management team following the completion of their MBO of an enforcement agents. The agreement permitted the management team to subscribe for further shares at a “sweat equity” value providing the target met certain financial projections.
- Creating a pool of EMI shares in NewCo prior to a management team’s MBO of a recruitment company. The pool was created to incentivise those employees placing candidates into roles with employers in the natural resources sector.
An MBO can be a complex undertaking. The structures are flexible. With this flexibility comes a degree of expertise required to navigate the deal to completion and handle the vast quantity of paperwork to achieve the desired goals. Using our experience, we work with the management team to streamline the process and effect completion with minimum cost. An MBO is different to the majority of corporate transactions, and thus experience is key.