How do I plan a management buyout?

In some cases, an MBO is the best answer

Dominoes

Our team provides lead advisory services to business owners and management teams throughout the MBO process and supports clients through five critical areas. 

  1. We help you design deal structures that work for buyers, sellers, and lenders and equity investors where necessary. 
  2. We secure funding to help management teams afford to acquire their stake in the business where necessary. 
  3. We work in collaboration with our tax team to understand and advise on the different tax consequences of different MBO structures for both the buyers and sellers;
  4. Our specialist team work with you to understand and calculate a commercial valuation that is suited to the proposed MBO structure; and, 
  5. We will ensure that everyone is prepared for the renewed responsibilities that come from external funding and life post-MBO.

What is a management buyout?

In its simplest form, an MBO involves a company’s management team combining resources to acquire all or part of the company they manage. Most of the time, the management team takes full control and ownership, using their expertise to grow the company and drive it forward.

An MBO may offer a vendor an attractive alternative to sale to trade for a variety of reasons; for example, the number of potential trade buyers may be limited, the vendors may be nervous about approaching competitors and disclosing sensitive information, or they may feel strongly that the company and its staff carry on independently in what they believe to be “safe hands”.

In considering an MBO, a number of considerations need to be made, such as the desire and credibility of the management team buying the company, the availability of funding and whether all parties involved can agree upon the funding mix. If all the boxes can be ticked, the MBO route can provide a vendor with the assurance of their company’s future success and the management team with a significant opportunity to benefit from future successes.

The hallmarks of a business that would facilitate a successful MBO are:

  • A company with a good track record of profitability;
  • Good future prospects for the company without high-risk factors;
  • A strong committed management team with a mixture of skills;
  • A vendor who is willing to explore a sale to the management team and who will accept a realistic price;
  • A deal structure that can be funded and supported by the future cash flows of the company.

Advantages

For a company undergoing a change in ownership, the management buyout route offers advantages to all concerned. Most obviously, it allows for a smooth transition of ownership. In addition, since the new owners know the company, there is a reduced risk of failure going forward. Other employees are less likely to be concerned, and existing clients and trading partners are reassured it will be “business as usual”. Furthermore, the internal changes and transfer of responsibilities between the vendors and management remain confidential, while any due diligence required by funders is often handled quickly.

The strength of the management is a critical factor in contemplating the potential future success of the company. Therefore, any funders pay close attention to the skills, experience, knowledge and credibility of the management team as well as their vision for taking the company forward.  And while the management team can reap the rewards of ownership, they have to make the transition from being employees to owners, which requires a change in mindset from managerial to entrepreneurial, and all parties need to ensure this is a transition that is achievable.

Funding a management buyout

It is rare that a management team will have sufficient funds on their own to buy the company, and so finance is often needed to successfully balance what all parties are trying to achieve. Typical sources of finance include: 

  • Asset finance – Funding that enables businesses to leverage against the assets in the company, usually property, stocks or debtors, can be a very viable option to asset-rich businesses considering MBO;
  • High street and private debt – in addition to asset finance, banks will often consider providing a cash-flow term loan, repayable over 3-5 years to support an MBO. Private debt funds have become far more active in the market than high street lenders;
  • Private Equity (PE) – PE funds will focus on backing good management teams. If the growth prospects, underlying profits, team and business are strong, then funding an MBO using Private Equity is very realistic. PE funds can provide additional benefits beyond cash to help professionalise a management team, fill holes and expand the business;
  • Vendor loan notes – Often, the sellers have to help fund the transition and leave some of their consideration in the company as loan notes to be repaid over time.

Our established relationships across debt and equity providers mean we are then well placed to design MBO structures that work for all parties and introduce and negotiate the right financiers on the right terms to support the next stage of the business’ growth.

The tax consequences of an management buyout

Depending on the proposed MBO structure and funding, there can be various different tax consequences that both vendor and the purchasing management team will need to understand and, as required, put in place appropriate solutions for. Some examples of key variables that may need to be considered are:

  • Is the proposed MBO a share or asset purchase?
  • Will a NewCo be created for the purposes of the acquisition? 
  • If so, have they considered the implications of: 
  • Business Asset Disposal Relief (BADR, formerly Entrepreneur’s Relief) available to vendors; 
  • The EIS, Venture Capital Trust (VCT) eligibility for any Private Equity funders coming in as part of the deal; and, 
  • Any potential income tax liabilities for management.
  • Are there any further restructuring requirements that form part of the proposed MBO?
  • Is there an earn-out period for the vendors? – How this is structured may have implications for BADR entitlements.
  • Is Stamp Duty payable?
  • Is any bank interest tax-deductible from the borrowed?
  • What are the VAT considerations?
  • If external finance is sourced, who is receiving it – NewCo, the target company or individual purchasers? 
  • What are the expected exit options for the purchasing management team in the future that ensure they are not liable for income tax? 

The earlier you seek tax advice in your MBO process, the better it is, as it avoids undue delays further down the line and minimises potential tax burdens for all parties involved in the transaction. In addition, we work collaboratively with our tax team to ensure that the consequences of any decisions made as part of the wider transaction are weaved into the entire process and planned accordingly.

Considering a management buyout for your business?

Speak to us for more information or to see how we could help.

 

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Valuation and deal structure 

A further key component of the MBO process issue determining the purchase price and/or valuation of the target business. The typical valuation methodologies for UK companies are also applicable to MBOs. Our team have extensive valuation experience and can provide both sides with a well-researched and evidenced guide to what fair value should be, why, and in what scenarios the buyers can increase the valuation for when they sell in time. 

Beyond valuation, it is also important to understand the deal structure in regard to the timing of payments to the seller and if there are any conditions on performance related to future payments.  

To support management, we will typically assist them with:

  • An outline of the future business plan and forecast
  • A detailed understanding of the company financials, including normalised working capital, normalised profit, cash and debt;
  • Up to date, fair asset values of any equipment intended to be used in asset finance arrangements;
  • Impact of any discounts that may need to be applied;
  • The company’s current debt capacity, if further debt is intended to be used as a source of funding; and
  • Anything that may impact future growth or free cash flows of the business.

These factors will all be considered when calculating an appropriate valuation for the business. In addition, it will ensure the affordability of the intended capital structure for the incumbent management team after the MBO is completed.

The MBO Process

The key steps of a management buyout process include: 

  1. An initial appraisal of the business at a high level based on understanding the company financials, market, services, people and growth prospects; 
  2. Understanding what the sellers are trying to achieve and how committed the MBO team are; 
  3. Supporting the MBO team in the development of their business plan and detailed financial forecast to understand growth, affordability and debt servicing capabilities in detail;
  4. Undertaking the valuation and evaluating the ideal deal structure; 
  5. Detailed financial analysis conducted, including testing the forecast financial model to show the serviceability of debt and returns to potential investors;
  6. An evaluation of possible tax consequences is undertaken;
  7. Approach to funders, a small buyout may involve just one funder while in the case of larger transactions, several funders may handle the financing;
  8. Offers from financiers come through, and the deal terms are negotiated; 
  9. The preferred financiers are selected, and due diligence starts; 
  10. Legal drafting and tax consequences are appraised in detail, including any necessary communications with HMRC; 
  11. Any issues from Due Diligence are raised addressed; 
  12. Completion and change of ownership takes place; 
  13. We prepare the management team for their first board meeting.  

The MBO process can take several months, so the vendors and management team must be prepared to fully commit to the transaction for that time frame. This can be challenging since the company must be run as normal and kept on track while the transaction is ongoing.

If you would like further information and to see how we could help, contact us on the form below.