A guide to Management Buy Outs (MBO)

An MBO can offer a business owner an attractive option for planning the succession of their business as they head towards retirement. 

Owners have the option of a 3^rd party sale or taking advantage of certain tax efficiencies offered by an Employee Ownership Trust.  Where neither of these are practical or desired an MBO can provide an efficient mechanism for an owner to exit.

Typically, MBOs are associated with a scenario where:

• A company is run by a strong management team.
• The company has a good profit record.
• Either this can leverage sufficient finance for the management team or the vendor is willing to put their faith in the business to continue to deliver the necessary returns to fund their exit value.

They can be particularly suitable for family businesses who have a more emotive connection with the business and investment in ensuring that the employees and other stakeholders are considered as part of their succession plan.

What is an MBO?

The term MBO encompasses any transaction where the management team of a business collectively acquires a stake in or the whole of the company or group of companies operating the business.

The benefits of an MBO are:

• They allow for a business owner to profitably exit in a scenario where there may be a limited 3^rd party sale market.
• They provide more certainty and comfort to employees and stakeholders than a 3^rd party sale.
• Professional fees associated with such a transaction can be lower than in a 3^rd party sale;
• They do not have the rigid conditions attached to an Employee Ownership Trust.

The potential risks associated with an MBO are:

• Structured incorrectly, the management team incentivisation may not be sufficient to drive the business and provide the profits necessary to settle the sale value for the seller.
• Where the management team is divided in terms of those who would like to become potential owners, this can cause friction.
• Depending on finance options, there may be a longer period of earn-out as compared with a 3^rd party sale.

How can the management team fund the exit value?

• Private funding by the management team - This is of course the simplest option in many respects and can be tax efficient where for example private pensions are used as the source of funds (Self-Invested Personal Pensions (SIPPs) and Small Self-Administered Schemes (SSASs).
• Debt financing - Normal commercial lenders do not tend to offer such facilities but private debt funds can offer fixed term loans.
• Private equity (PE) funds - A more common arrangement which sees PE funds subscribe for shares alongside the management team, as well as providing debt financing.  Management will be expected to inject a meaningful proportion of the overall capital or enter into a vesting period for their shares, which gives comfort to the PE fund that they will remain with the business in the medium term.
• Asset leveraging - Assuming there is the facility and asset base to do so, the management team could borrow against the value of the company's real estate or debtors.
• The vendor - The seller will often leave a portion of the exit value on deferred terms, recouping this value from the profits of the business over a number of years.  In a period of increasing interest rates making different forms of debt financing harder to cover.

What are the tax implications?

These can vary considerably based on how the transaction is structured.  There are a number of key areas that should be factored into early planning, to ensure that traps are not fallen into. 

These key areas are:

Sellers:

• Ensuring that the sellers achieve capital gains tax treatment as opposed to income tax treatment.
• Making use of any available tax reliefs, such as Business Asset Disposal Relief.
• Where there are deferred terms, liabilities could be deferred accordingly or there is sufficient liquidity upfront.
• Considering any wider tax opportunities in advance, such as considering the use of a trust for family inheritance tax planning, prior to a sale.

Ongoing Shareholders:

• Ensuring that any non-exiting owners do not suffer any tax issues as part of the transaction.

New shareholders:

• Providing the opportunity for any new shareholders to qualify for available tax reliefs where relevant.

It is therefore important that expert tax advice is taken early in proceedings.

What key factors need to be kept in mind as part of the process

Each transaction is different and needs advice and direction tailored to the circumstances.  There are however several common themes and so either side will need to consider the following:

• Forecasting will be required, and this will need to be tested and validated.
• Each side should consider independent legal and tax advice.
• A formal valuation will often be required for tax purposes, even when not obtained for commercial purposes.
• Submissions will need to be made to HMRC in order to obtain relevant tax clearances.
• Due diligence will be required by management to ensure they are comfortable with the companies reporting.
• Funding options may involve ongoing covenants, restrictions or obligations and both sides should be aware of the implications of these not being met.

How can we help?

As a firm, we have experts who have extensive experience in advising sellers, management teams and investors (both debt and equity) on all legal and tax elements of MBOs.

Our specialists regularly assist with:

• Corporate and tax structuring;
• Obtaining tax clearances from HMRC;
• Investor due diligence;
• Debt financing - including facility agreements, security and intercreditor arrangements;
• Equity financing - including loan notes and share allotment;
• Deal implementation  - including share/asset sale documentation and governance documentation (investment agreements and articles of association); and
• Employee and incentive arrangements.

Examples of our recent experience include:

• Foot Anstey completes management buy-out deal for Crondall Energy  | Foot Anstey

• Foot Anstey advises GW Global Insights' Management team on MBO | Foot Anstey

• Foot Anstey support management buyout for Cornish business | Foot Anstey