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Are you a key stakeholder in a business contemplating a management buyout? A management buyout is where the existing shareholders sell the business to the current management team, including the current owners and senior management of a company. This article will explain the mechanics of a management buyout and provide an overview of the key legal and commercial considerations all parties should consider.
What Are Management Buyouts?
As the name suggests, a management buyout (MBO) is a corporate transaction that transfers ownership in a business from the current owners to the current senior management.
MBOs are typical for companies that have passed the earliest growth stages and are moving into a more mature life cycle. This is for a variety of reasons, including the fact that most businesses in their earlier periods of growth tend to be managed by their owners. Alternatively, a company with an existing financial sponsor, such as a private equity fund, may look to sell their stake in the company to the management team.
A business best suited to an MBO will usually have:
- an established revenue stream and stable earnings;
- opportunities for further growth;
- an experienced and competent senior management team;
- a willingness on the part of the sellers to entertain a sale; and
- access to adequate financing.
Who Are the Key Parties in MBOs?
All MBOs require a seller (i.e. existing shareholders) and a management team prepared to acquire the business. Since most management teams do not collectively have enough cash lying around to fund the purchase, they usually will need to seek outside financing. This can come from a variety of sources, including:
- other equity investors, such as private equity funds;
- banking lenders;
- non-banking lenders (commonly called direct lenders or private debt lenders); and
- certain loan agreements with the existing owners.
Finally, because MBOs are technically complex transactions, both the seller and management team will usually need a team of advisers consisting of:
- lawyers;
- accountants; and
- corporate finance professionals.
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Structuring an MBO
An MBO can be structured in a variety of ways. The two most fundamental ways to structure the transaction are either through:
- a share sale; or
- an asset sale.
In a share sale, the only things that trade hands from the existing owner to the management team are the shares in the business’ parent company. The management team acquires the business as-is; the seller gets a clean break.
On the other hand, an asset sale is where you transfer the business’s critical assets to a new company incorporated by the management team. The management team pays the existing owners for the assets.
Financing the MBO
As mentioned above, the management team rarely has enough existing capital to acquire the business outright. Where this is the case, they will need to raise outside capital. Financing comes in two forms, including:
- equity; and
- debt.
Equity Financing
Equity financing is where a company pays investors shares in exchange for a cash injection. In practice, for MBOs, you will have two classes of investors:
- the management team; and
- third-party equity investors.
Most third-party equity investors want different shares than the management team. Preference or convertible shares entitle third-party equity investors to first rights on dividend payments. The implication is that they will receive dividends on any profit above what is owed to preference/convertible shareholders.
Debt Financing for MBOs
Debt financing commonly refers to loans provided to the management team (or the company itself), with the proceeds used to pay off the existing shareholders.
You can structure debt financing in several ways. First, a lender will usually secure the loan on the company’s assets. The company must then service the interest and principal repayments according to the loan terms. Finally, the lender will be entitled to use the assets to pay itself back if it cannot.
What Are the Legal Implications of an MBO?
As with any business transaction, the critical legal implications relate to allocating risk and liability. The purchase agreement will determine the scope of the risk and the extent of each party’s liability after the fact.
Many negotiations will be hashed out during and after the due diligence process. Unlike other business transactions, management will already have an intimate understanding of the ins and outs of the business. This means the parties can expedite the due diligence process because the buyers should already know of any unusual aspects inherent to the business.
What Are the Tax Implications of an MBO?
One of the critical functions of a deal team for both parties is to optimise the tax position. Nevertheless, the tax liability of each party will depend on numerous factors, including:
- how the deal is structured;
- if a new company will be incorporated into the sale process;
- what tax credits are available;
- the extent of stamp duty either party will owe;
- how any debt financing can be used to offset future tax liabilities; and
- what the management team’s intention is regarding their future exit from the business.
Key Takeaways
An MBO is a business transaction where the existing shareholders sell to the management team. Because both parties should be more closely familiar with the particulars of the business than in an arms-length transaction, there are certain advantages and disadvantages to MBOs. Both parties must instruct a deal team to advise them throughout the process. The deal team, which should consist of legal advisers, an accounting team, and financial advisers, will help them structure the deal most optimally (depending on the negotiating position of each party). They will also advise on the financing of the transaction.
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Frequently Asked Questions
A management buyout is where the existing shareholders sell the business to the current management team.
As with every business transition, the buyer and seller must negotiate how to allocate the risk. Unless the management team has sufficient cash, they will need to raise outside financing. They will seek equity and debt financing. The deal team will advise on how to fine-tune the transaction.
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