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What is a ‘Management Buyout’
A management buyout (MBO) is the name given to the transaction whereby the management of the target company (MBO Team) purchases the issued share capital or the assets of that company (target), often through a holding company (Newco).
MBO’s can be difficult to navigate but Berry Smith have the specialist knowledge to assist with such transactions.
What does a MBO involve?
The MBO Team is usually made up of some or all of the target company’s directors but it is not uncommon for senior employees to be involved as well.
The MBO Team and their advisors will need to consider how the deal will be structured, for example, will Newco acquire the issued share capital of the target or just its assets?
Another initial consideration will be in establishing how the transaction will be financed. The transaction may be financed by a separate ‘private equity’ investor, via a loan from a bank, by MBO Team personally or a combination of any of these.
If part of the funding is to come from equity finance (unlikely in smaller deals), it is important to consider the extent to which any shares in Newco will be issued to the investor. A careful balance will have to be struck if the MBO Team is unwilling to give up control of Newco. If equity finance is being sought then it will be important for the MBO Team to prepare a business plan for the target as it is likely that it will be this plan that attracts the investor in the first place.
The bulk of the finance for the Management Buyout will often be formed by a bank loan. This will usually be secured over not only the assets of Newco, but those of the target as well. Depending on the amount of the loan, the bank will almost certainly require individual members of the MBO Team to provide personal guarantees and security over their personal assets.
Any banks providing finance for the transaction will want to know at an early stage the precise structure of Newco so it is important that due consideration is given to such matters such as who will be the first directors of Newco along with what Newco’s authorised and issued share capital will be.
The MBO Process
- Due Diligence
A management buyout is complex, and the MBO Team will need to carefully consider the extent, if any, of the due diligence exercise to be undertaken. Whilst the MBO Team may have been operating the business, they may not be aware of every aspect of the target.
On an MBO, the due diligence exercise assumes an even greater importance for both the private equity provider and the debt provider. Because the MBO Team will already have a good knowledge of the business, the seller may be prepared to give only limited warranties (see below). The private equity provider and debt provider, by contrast, will not have the benefit of the MBO Team’s knowledge and will therefore want to carry out an extensive due diligence review.
When undertaking a management buyout this can often be the most contentious issue. The seller will usually argue that the MBO Team should have a better knowledge of potential liabilities and other matters facing the business, especially at an operating level. As the MBO Team will have built these factors into the proposed purchase price already, the seller would argue that Newco should not be able to seek further redress through a warranty claim.
Nevertheless, Newco should insist on warranties to cover at least those areas of the business with which the MBO Team has had little or no involvement. For example, where the target business is part of a group and management was not involved in the insurance, tax, property, intellectual property or pensions aspects of the business (because these were dealt with at group level), the MBO Team should seek full warranty cover in relation to these matters.
- Legal Documents
The MBO team and their advisors will need to prepare the legal documentation to put into place the buy-out, for example, the share / asset purchase agreement, a tax deed / covenant, the bank finance documentation, any contracts of employment / service agreements for the directors of Newco and an investment agreement for a third party investor or the MBO Team themselves.
The shareholders of Newco may also consider having a shareholders agreement. This may include provisions restricting shareholders selling their shares without offering them to other shareholders first, protecting minority shareholders; and provisions where, in certain circumstances a member will be forced to sell their shares to the other members of the MBO Team, which are known as ‘Good Leaver’ (for example, where a shareholder has died) and ‘Bad Leaver’ (for example, where a shareholder is convicted of a serious criminal offence).
- Exchange and Completion
This is the final stage of the buyout process. All relevant documents will be signed and the acquisition of the target company (or its assets) will actually take place.
- Post Completion
There will be a number of post completion matters which will require attention such as ensuring all necessary filings are made at Companies House. If relevant, it is also important that all registries are updated of any change in the ownership of assets such as land or intellectual property. When the transaction is a share purchase, the stock transfer forms should also be submitted to HM Revenue and Customs, so the appropriate amount of Stamp Duty can be paid.
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