Management buy out

One of the big advantages of a Management Buy Out is that because the existing management or some of them buy out the current owners, relations are typically good and there is intimate knowledge of the business. This means a Management Buy Out transaction can often proceed more quickly and smoothly than an arm’s length sale of a business to a 3rd party.

The structures for an MBO are flexible. With this flexibility comes a degree of expertise required to navigate the deal to completion and handle paperwork involved. To make the transaction proceed quickly and smoothly it is essential to have practical, proactive, highly commercial lawyers involved.

Whether you are on the sell side or buy side, we provide a great alternative, in approach and fee savings, to the big law firms. If you need lawyers for an MBO transaction, please do give us a call.

How an MBO works

Routinely, a company is set up, a NewCo, to purchase the shares/assets of the existing company. 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 existing business, 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 also dealt with MBOs that are funded via the use of EMI options.

There are alternatives to an MBO which we can consider for you such as trade sales and employee share ownership trusts.

What are the advantages of an MBO?

MBO’s often generate excitement and have a feel good factor but aside from these reasons, they often make commercial sense because :

• they offer continuity for the business – which is often favoured by employees and key customers and suppliers.
• risks are generally lower – for both buyers and sellers and sellers may be prepared to accept some form of enhanced earn out with confidence.
• costs and speed of transaction – the costs should be lower because there will not typically be as much due diligence, arguing over warranties and deal structures.

How is an MBO financed?

Typically a Management Buy Out is financed in the same way as any other business purchase,. Where external finance is needed, obtaining and satisfying lenders or new investors tends to be the more difficult part of the transaction. Many MBO transactions are financed by a mixture of cash, debt and equity.

However, It is not uncommon for the management buy out to be financed by the seller, i.e. the owner of the existing 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.

Are Seller warranties still relevant in an MBO?  

Yes, because whilst many management buyout teams will have had an active role in the target company’s decision making, this is not always the case, as the company’s articles or any shareholders agreement may have limited the management team’s input.

The management team will want the seller to warrant certain matters, e.g. that the company 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 target company may have ongoing or future liabilities which are in dispute. The management team needs disclosure on liabilities and should 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.

Legal advice can quantify the risks for the management buy out team. Often the problems are solved by capping indemnities which provide a practical solution.

Restrictive covenants

The management buy out team will almost certianly want to restrict competition from the current owners. 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.

Share incentives

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. EMI options will be the most popular but there are other choices if EMI is not suitable. We can deal with this for you.

Lawyers for a Management Buy Out

As you will have noted above, we have highly practical, highly experienced corporate lawyers who focus on the core issues in a buy out transaction. Please do get in contact to discuss your transaction, our fees and how we can help..