We are equally as experienced in working with MBO teams as we are the vendors. The structures for an MBO are flexible. With this flexibility comes a degree of expertise required to navigate the deal to completion and handle what can be the quantity of paperwork involved.
Based on past experience we explain:
- How a MBO works
- Issues for the sellers
- Considerations for the MBO team
- Typical legal documentation needed
How a management buyout works
The common characteristics of a MBO are:
Set up a company to acquire the business from the selling shareholders
- Routinely, a company is set up, a NewCo, to purchase the shares/assets of the existing 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 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 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 buyout with the most powerful lender advancing loans to the company most likely to be able to pay out.
Representing the Sellers
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.
Representing the MBO team
We review documentation that has been prepared by the current owners or the financiers. Our skill is to advise the buyers on the commercial risks and their rights and obligations under the transaction. We will flag up areas where the position for the management buyout team can be improved.
Our lawyers usually represent the entire team but can act for individual members of the management buy out team if required.
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 experienced solicitors pick 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 negotiable. Typical areas to think about include:
- The level of warranties given and by whom
- What potential liabilities are the parties seeking to indemnify
- Post acquisition restrictions on competitive trading
- Level of due diligence
- Investor protections
- Share incentives for the team
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.
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.
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.
It is not uncommon for private investors to insist on various protections. The protections will be set out in the articles and or the shareholders’/investment agreements. We will tell you what is reasonable based on our experience of previous transactions.
Typical areas for legal advice include:
- Board composition.
- Veto rights
- Transferring shares
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.