Management buy-outs

A management buy-out (MBO) is a sale of the company to the people who are already running it. The owner gets an exit without having to find an outside buyer, the managers get to own the business they’ve been working in, and the price is usually paid over several years out of the company’s own profits.

I act on MBOs for owner-managed companies, whether you’re selling your business to a management team or you’re buying the business from the current owners. I will typically act for the management team, although I can act for either side.

How a buy-out is usually put together

The managers don’t usually have the purchase price available themselves, so often a new company will be formed to buy the shares from the owner under a share purchase agreement. Part of the price is paid at completion, either from the managers’ own money or from a lender, and the rest is left outstanding and paid in instalments over a period of years. That deferred part is sometimes documented as loan notes and sometimes simply as deferred consideration in the agreement, but either way the money to pay it comes from the trading company as it earns it.

As examples, I’ve acted on a £4.5m buy-out of a lift company, where the price was paid over five years, and I’ve recently completed a £1.7m buy-out of a shop fitting company, which is again being paid over a number of years. Whether the business can afford the payments is the first question on any MBO, and it’s one for the accountants to look at before the legal work starts.

If the team is still working out where the completion payment will come from, I’ve written about how to raise finance to buy a business.

What the seller needs from the documents

You’re selling to people you know and probably like, and you’re also in effect lending them most of the price, so the documents need to protect you without damaging the relationship.

Protection generally means security, such as a debenture over the company’s assets, a guarantee from the trading company and sometimes personal guarantees from the managers. It also means controls while the money is outstanding, such as limits on dividends, on directors’ pay rises and on selling assets, together with a clause making the whole balance payable at once if an instalment is missed. If a bank is lending as well it will want to rank ahead of you, and the extent of that priority has to be negotiated. There’s more on this in my article on deferred payments in business sales.

The warranties are also approached differently on an MBO. On a sale to an outside buyer you give long warranties because the buyer doesn’t know the business, but on an MBO the buyers often know it better than you do, particularly if you stepped back from the day-to-day running some time ago. A seller in that position can reasonably resist giving warranties about things the managers have been running themselves.

What the management team needs

The team is taking on a debt and, quite often, their first shareholdings. They need to agree the arrangements between themselves, including who holds what, who decides what, and what happens if one of them leaves, falls out with the others or dies before the seller has been paid. That belongs in a shareholders’ agreement, and it’s better to put it in place at the start than to try to agree it a few years later.

They also need to understand what they’re signing up to personally, particularly if they’re giving a personal guarantee, and the restrictions which the seller wants during the payment period have to leave the team enough room to run the business. If the seller is staying on for a handover, the terms of that should be written down as well, including how long it’s for, what the seller will be doing and how they’ll be paid.

Who I act for

On an MBO I will typically act for the buyer, meaning the management team and their new company, and the seller rarely gets independent legal advice. On larger deals sellers can and do instruct their own solicitor, and of course I can act for either side.

I can only act for one side on any deal, so if I’m acting for the team then I’m not advising the seller, and the seller needs to understand that before signing anything. If you’re the owner and you’d like me to act for you instead, I’d be delighted to.

Tax advice

How the deal is structured affects the tax the seller pays and the way the new company funds the instalments. I don’t give tax advice, so I work alongside the accountants and make sure the documents reflect the structure they’ve advised on.

How long it takes and what it costs

An MBO usually takes two to three months, although it can take longer, and having a lender involved tends to add to that. Because the parties already know the business, due diligence is normally lighter than on a sale to an outside buyer.

I work on fixed fees, with a written scope of work agreed before I start. The fee depends on the size of the deal and how much work is involved. On a sale or purchase between £500,000 and £5m it’s usually between about 1% and 3% of the price, and the percentage falls as the deal gets bigger. Most full sales and purchases start at around £10,000 plus VAT, and a management buy-out usually costs less than a sale to an outside buyer, as there’s less to negotiate.

Next steps

If you’re still deciding whether a buy-out is the right route, my article on the advantages and disadvantages of a management buy-out is a reasonable place to start. Otherwise, get in touch and let me know who is buying, the price and how it’s going to be paid, and I’ll come back to you with a fixed fee and a scope of work.