A client recently commented that the posturing (or as some might say strategic negotiation) going on between the UK government and the European Union at the moment reminded him of the negotiation (or some would say strategic posturing) he witnessed during the negotiation of a management buyout (MBO) a few years ago.
On the surface both parties were extolling the virtues of quickly coming to an acceptable, profitable and commercially viable agreement.
Behind the scenes however, each party was working hard to gain small but potentially significant concessions in order to tilt the balance of the transaction paperwork and terms in its favour.
MBOs are often portrayed as an easy exit opportunity for business owners and a great opportunity for management teams to take control of their own destinies.
Putting a successful MBO together however requires a mixture of strategic planning, solid financial projections to support funding arrangements and, of course, existing owners willing to exit on terms which can be less favourable than those available as part of a trade-sale exit.
So what are the key areas that management teams who are, or could be, considering an MBO should be thinking about?
What’s in it for the existing owners?
There are a number of advantages to the existing owners of exiting via an MBO, including:
- it prevents the existing owners seeing their business absorbed into that of a competitor, as can happen in trade-sales
- the management team will have a good understanding of the business’ existing trading position, meaning the due diligence process is less likely to reveal something prompting an attempt to reduce the price
- fewer warranties need to be provided to the management team as part of the sale process than would be sought by a trade buyer, providing the sellers with a cleaner break from the business; and
- the sellers will not need to disclose sensitive information about the business to a rival offering to purchase the business who could later withdraw from negotiations.
What does an MBO transaction structure typically look like?
An MBO transaction structure generally will involve the management team incorporating a new company (Newco) that will act as the buyer of the target business.
This provides an opportunity for the management team to discuss and negotiate the terms that will apply between them in relation to their equity stakes in Newco and how they will take decisions regarding the management of the target business following completion.
How are MBOs typically funded?
The management team will generally invest their own money into Newco, but funding an acquisition will generally also require third party funding by way of (and often a combination of):
- debt finance (bank lending)
- a private equity (PE) investor supporting the transaction
- the sellers accepting payment of the purchase price on deferred terms over a number of years following completion (so that the management team can fund the acquisition from the future profits of the business).
A transaction supported by PE funding provides further issues to consider for a management team. PE investors will generally look to pass a proportion of the transactional risk to the management team so that if, for any reason, the MBO does not prove profitable or successful, the PE investment may to some extent be insulated.
The terms of the investment agreement will generally involve the management team giving warranties to the PE investor regarding the reasonableness of assumptions or projections in the business plans.
Additionally, PE investors will expect the management team to commit to the business for a significant period following completion (often towards an agreed exit point) with a reduced share price applying should any member of the team look to exit outside of the agreed timetable.
It is not uncommon for ‘bad leavers’, who depart prematurely or in acrimonious circumstances, to only be paid the nominal value of their shareholding.
A PE investor will also expect to have a say in how the management team run the business. Management are wise to argue that onerous PE investor involvement benefits neither party, and should push for any step-in rights for the investor to extend only to business-critical events such as insolvency or a material breach of the investment agreement.
If you only take one thing away one thing…
Support from lawyers, corporate finance advisors and tax advisors experienced in putting MBOs together is often crucial to ensure a successful MBO. Management teams should engage with advisors at an early stage to ensure a sensible transaction structure is put together and good funding terms agreed.
James Worrall is a partner in the corporate & commercial team at Royds Withy King, specialising in mergers and acquisitions, corporate structures and group reorganisations (including demergers) and exit strategy. James is recognised in the Legal 500 2017 as a Next Generation Lawyer and in Chambers and Partners 2018 as an Associate to Watch.