Management Buy Outs

What is a management buyout?

A management buyout (sometimes referred to as a “management buy-in” or “employee buyout”) is when the existing management team in a business buys the business from its current owner, rather than selling to a third party buyer. This can be an attractive exit-strategy for many business owners, as the business will be left in the hands of the incumbent management team, and often results in a smoother exit process.

Management buyouts can be popular to transfer ownership in a family business setting, however they are not exclusively so and are popular in private businesses of various sizes.

A successful MBO can offer the current owner an exit from the company whilst having as much assurance as they reasonably can that the business grows under the stewardship of the existing managers. Management buyouts are often popular with all the employees within the business as they will already be familiar with the current management team, and therefore the management buyout process can be easier to manage.

How is a management buyout different from a usual business purchase?

The fundamental steps in purchasing a business remain the same. However, there are some key differences with a management buyout:

1. Route to funding. It can be easier to secure funding for a management buyout, as a potential lender may be reassured that the existing management team is already running the business profitably which is a good indicator as to the lending risk. Often, management buyouts are attractive to private equity firms as the management team is often a key driver to the success of the business prior to the management buyout, and by keeping that dedicated management team in place, there is a greater chance of a successful mbo.
2. Less due diligence. The existing management team will typically already have intimate knowledge of the target company and its business. Therefore, they should already know most of the key information on the commercial side of the business.  Therefore, the due diligence process should be simpler and faster. There is often a more collaborative approach between the management team and the sellers.
3. Fewer warranties. The outgoing sellers are likely to be asked to give fewer warranties than an arms-length buyer who has no direct knowledge of the business.  This means less risk for the sellers.  On the other hand, if other private equity investors (or private equity funds) are involved to fund the transaction, they may insist on extensive warranties being given by both the current owners (in their capacity as seller) and the management team (in their capacity as new owners).
4. Smoother transition. An management buyout is likely to have a much smoother transition, as the management team will already be known to the existing staff, suppliers and customers.

How are management buyouts structured?

It is sensible for the management team to take expert accounting advice on how best to structure the management buyout. In addition to considering whether to purchase the company’s shares (rather than just the company’s assets), the potential buyers should also consider whether to purchase the business individually, or whether they should incorporate a new company.

Many considerations around structure will be influenced as to whether the management buyout is to be funded by equity investment or private equity funds, traditional financial institutions, whether part of the consideration will be made up of loan notes, or whether it should be structured as a leveraged management buyout.

What is a leveraged buyout?

A leveraged buyout is much the same as management buyout (or buy in management buyout), the main characteristic being that a significant portion of the finance is raised by borrowed money or asset finance, rather than through private equity financing. For example, the management team will borrow funds and use the company’s assets as security in order to raise those funds.

Things to consider as part of the MBO process

When considering a management buy out, the following issues should be discussed at the outset:

• Before the management team takes over the business, have they undertaken a detailed financial analysis of the business? Have they got a robust forecast financial model? If the buyer needs to raise external funding, these issues will be very important to secure that investment. Consider also whether the management team is prepared to offer any required security. These issues may also factor into what ownership stake each of the buyers will take in the business.
• How will it be structured? Will it be an asset purchase or a share purchase?  Will a holding company be put in place?
• If the structure is a share purchase, are there any other assets crucial to the success or future development of the business which need to be transferred into the business prior to completion (for example, any intellectual property rights which might be held by the sellers personally).
• How will the purchase price be paid for? Does the management team have sufficient cash to fund the management buyout, or will they need to obtain either debt-financing from a lender, or take on investment from private investors?
• What will the company’s management look like after completion? Do the buyers want to bring in other employees who may not be part of the existing management team?
• Putting a shareholder agreement in place from completion for the new owners. For more information about shareholders agreements is available here.

If you need any advice on management buy-outs, please contact a member of our corporate and commercial law team in confidence here or on 02920 829 100 for a free initial call to see how they can help.