Are you considering a Management Buyout?
Is a Management Buyout (MOB) the Right Choice for Your Business?
A management buyout (an MBO) can be a big decision for everyone involved and the structure of an MBO is likely to be very complex. The main things to conside as per our mergers and acquisitions advisors are:
✔️ What value does an MBO have for a business’ future?
✔️ Do all parties involved in an MBO truly benefit for an MBO transaction?
This article sheds some light on MBOs and what you need to consider before committing to such a M&A transaction.
What is a Management Buyout?
An MBO is where an existing management team of a company acquires a majority or all of the company’s shares from its current owners and shareholders. At the end of this transaction, the managers will acquire control and ownership of the business they work for.
There are several reasons why an MBO might take place:
✔️ Continuity: the management team wants to maintain the company’s current operations and strategic direction without disruption.
✔️ Opportunity: the management team sees potential in the company’s business and wants to drive growth and performance through ownership.
✔️ Strategic independence: an MBO will allow the management team to implement their own idea without interference from owners and shareholders.
Typically, an MBO will occur when the current owners of a company, e.g. a Founder, decide to sell their shares and exit the company. Instead of selling shares to third-party buyers, the existing management team can negotiate to acquire the business themselves.
How does an MBO work?
In an MBO, the management team could form a new company or special purpose vehicle to acquire the shares of the target company. It is common for the management team to secure financing from various sources, such as private equity firms, venture capitalists, corporate loans from banks, or (if available) by using their own funds. Negotiation of purchase terms in the transaction, involving a valuation of the target company and conducting due diligence, are typical elements of an MBO.
It is worth noting that MBOs can be complex from the legal, financial and operational considerations. Professional advice from lawyers, accountants and business consultants is often sought to ensure a successful transition of the ownership.
What are the legal considerations of an MBO?
In English Law, an MBO involves several key considerations:
✔️ Confidentiality and Non-Disclosure Agreements: prior to engaging discussions about the MBO, the management team is likely to sign confidentiality and non-disclosure agreements to protect sensitive information shared in the negotiation process.
✔️ Due Diligence: the management team should conduct thorough due diligence to assess the target’s legal, financial and operational aspects. Due diligence helps the management team to identify any risks, liabilities, or potential obstacles, which may lead to a stronger negotiation position.
✔️ Valuation and Purchase Terms: the valuation of the target needs to be determined, and this can affect the negotiation of a payment structure, potential earn-outs, warranties and indemnities in a contract.
✔️ Shareholder Agreements and Articles of Association: existing shareholder agreements and the articles of association of the target company need to be reviewed, and potentially amended, to confirm a change of ownership through an MBO can be implemented.
✔️ Financing Arrangements: the management team will need to secure financing for the MBO. The terms of any legal documentation, such loan agreements and security documents, should be reviewed properly.
✔️ Employee Issues: an MBO can affect the employees of the target company. Employment contracts, benefits and pensions will require review, and advice should be sought in how to implement consultation and ensure communication with existing employees.
✔️ Regulatory and Competition Law: there may be regulatory and competition law considerations depending on the nature of the target company’s business. Obtaining necessary approvals and clearances may be required before completing the MBO to ensure compliance with the law.
✔️ Director’s Duties and Fiduciary Obligations: if any of the management team are directors, they still need to consider their fiduciary duties throughout the MBO process. They must act in the best interests of the target company and its shareholders, avoid conflicts of interest and ensure transparency in the transaction.
✔️ Documentation and Contracts: the MBO will require various legal document to be prepared, such as a sale and purchase agreement, shareholder agreements, financing agreements and ancillary contracts. Each document needs to clearly outline the terms of the MBO and fairly protect the interests of the parties involved.
Each MBO is unique and specific legal considerations will depend on the size of the transaction. Seeking legal advice from professionals specialising in corporate and commercial law will help a management team navigate the complexities of an MBO.
How can you finance an MBO?
The management team is likely to combine different sources to fund an MBO, but typically methods of financing an MBO include the following:
✔️ Equity Investment: The management team may invest their own funds into the target company, this demonstrates their commitment to the success of the MBO and helps attract other investors and lenders.
The management team could also approach private equity firms to provide capital in exchange for a holding in the target company. A private equity firm can bring its strategic guidance and access to networks to help grow the business of the company.
✔️ Secured Financing: Bank loans are a common source of funds for MBOs, and these loans are usually secured against the target company’s assets and cash flow. The loan terms and interest rates are usually dependent on the financial strength and creditworthiness of the management team.
Lenders do not always have to be from a bank. Crowdfunding platforms, peer-to-peer lending, and even loans from the current owners, can all be explored to finance an MBO, but the commercial returns and interest payments need to be considered by all parties before formalising any arrangements.
✔️ Mezzanine Financing: This form of finance combines elements of debt and equity. Essentially, there is a form of subordinated debt, which ranks below senior debt but above equity in terms of priority of repayment.
✔️ Earn-outs and Contingent Payments: A portion of the repayment terms can be dependent on the future performance or financial performance of the target company. This can be good way to bridge the valuation gap and incentivise the management team to drive the growth of the company and its business.
In any event, the management team need to consider the financial health of the target company, their own track record, the industry the target company is in and any prevailing market conditions. Engaging with financial advisors and business consultants specialising in M&A can help the management team explore the most suitable options for financing an MBO.
How can Dragon Argent help you with Management Buyout?
Conducting a management buyout can be daunting, but a successful transaction can often meet the needs of all stakeholders and create a unique win/win outcome. Dragon Argent has worked with a number of management teams and owners on successful management buyouts. Are you looking to explore options for selling your business via a management buyout? Are you a manager looking to buy a business that you operate?
Get in touch by scheduling a discovery call today to discuss how we can be helpful.
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