A guide to management buy-outs (MBO): What business owners need to know

What is a management buy-out?

Management Buy-Outs (MBOs) are a common and strategic option for business owners seeking to implement a succession plan or facilitate an ownership transition. In an MBO, a company’s existing management team acquires all or part of the business, providing continuity and operational stability.

Even though MBOs offer a number of advantages, they also involve complex legal, financial, and structural considerations. This guide outlines the key stages of a MBO, explains the potential benefits and risks, and highlights important factors for business owners to consider when assessing this route.

Why choose a MBO?

For many businesses, finding a suitable third-party purchaser can prove challenging, however a management buy-out offers a favourable exit for business owners. Selling the business to an ‘internal’ purchaser ensures a more simplistic, efficient process and continuity.

The preexisting relationship between the management team (MBO Team) and the seller not only ensures more amicable negotiations but also a smooth transition which further benefits a business’ customer base through a sense of continuity in the way a business will operate post-sale. A MBO may preserve the legacy of the business as the incoming management team will utilise their existing knowledge of the business operations thereby driving its future success.

How does the MBO process work?

Before proceeding with the MBO negotiations, a valuation of the business should be undertaken to determine a fair purchase price for the incoming MBO Team. Following this valuation and agreeing the purchase price, one of the most significant challenges for the MBO Team is raising the required capital which could involve a mix of cash and debt. The funding can be both external (banks) and internal (cash at bank) as the newly incorporated company (Buyer) would be able to borrow the surplus cash from the target to make payment for the full or part completion payment to the Seller.

Commonly, the seller is willing to support the financing of the transaction by issuing loan notes to the MBO Team. A loan note operates similarly to an IOU and will be repaid with future company profits. However, security such as personal guarantees from the MBO Team and charges over the assets of the company in favour of the seller will be expected to secure future payments.

Steps:

1. Drafting “Heads of Terms” outlining the terms, funding and structure of the deal.
2. The MBO Team undertakes a light touch due diligence process, aided by their existing awareness of the business, its performance and its practices.
3. Incorporation of the company through which the incoming MBO Team will purchase the shares or assets in more limited circumstances of the company .
4. Drafting of the legal documents including
   • new articles of association
   • the share/asset purchase agreement,
   • loan documentation; and
   • any other legal documents to give effect to the transaction and implement the incoming MBO team as the new business owners.

Legal considerations in an MBO

In a large number of cases the out-going owners will retain some level of involvement in the business as employees, particularly in instances where the transaction is funded using loan notes. As a result, contracts of employment should be put in place to include proportionate remuneration as well as leaver provisions and non-compete clauses, a process in which our employment team would be happy to assist with.

Common pitfalls to avoid in MBO transactions

A common pitfall when negotiating a MBO might include overlooking warranty protection for the purchaser. Although MBO Team will have a more intimate knowledge of the business than a third-party purchaser, it is fundamental that the incoming management team are not under protected.

That being said, the MBO Team may also have access to new business information during the due diligence process they otherwise would not have. Maintaining confidentiality is fundamental should the transaction not come into fruition, therefore, a confidentiality agreement may be necessary prior to any disclosure.

MBO Teams will often fail to anticipate the extent of potential securities that the seller or their lenders, will require to finance the acquisition and our Business Services experts have extensive experience guiding owners and management teams through MBOs across a range of sectors and will be able to assist throughout the entire process.

Get in touch with our London Business Services team

Whether you are looking to exit, support your management team in taking ownership, or explore funding and legal structuring, we are here to help you navigate the process from start to finish.

Get in touch today to book a confidential consultation with our expert London team.