By Craig Malarkey, Partner in the Corporate and Commercial Team at Swinburne Maddison LLP
Management buyouts (MBOs) are a popular strategy for executives looking to take ownership of the companies they manage.
Experian data showed an increase in these transactions year on year for 2022 and 2023. While the market for trade sales and private equity investments remains active, an MBO can be an attractive exit strategy, allowing the management team to step up and can be potentially less impacted by external market forces.
An MBO involves the management team acquiring a significant portion, if not all, of the company’s shares, often with the help of external financing or vendor support. While MBOs offer benefits like leadership continuity and deep business understanding, they also come with legal complexities that require careful navigation.
Structuring the deal
An MBO typically involves a share purchase from the current owners, often through a newly formed holding company (Holdco). Some sellers may wish to exit outright, whereas others may “de-risk” by selling only a proportion of the shares. Establishing this early is crucial as it impacts the deal’s structure and the seller’s ongoing involvement.
Financing the MBO
Financing an MBO adds another layer of complexity. Management teams often lack the capital to buy the company outright and must rely on external sources or other payment structures.
Private equity firms, which specialise in buyouts, are a common option. Management teams must engage early with advisors, including lawyers and corporate finance specialists, to ensure the deal works for all. PE expertise can significantly benefit the management team, though legal documentation can be complex.
Other financing methods include traditional bank loans, where company or personal assets may be used as collateral, and seller financing, where the current owner agrees to receive payments over a period of time. Seller financing is often easier to negotiate in an MBO due to the seller’s vested interest in the management team’s success. However, sellers should carefully consider their risk and exposure, potentially retaining some interest or taking security.
Each financing method comes with legal considerations. For instance, bank loans may impose operational covenants, while private equity deals often require negotiation over control and future exit strategies.
Legal Due Diligence and Ancillary documents
Legal due diligence is critical in any acquisition, though it is often minimised in MBOs. The aim is to obtain a full understanding of the business, including financial performance, market position and hidden liabilities that could affect the transaction. While the management team’s familiarity with the business might allow for reduced due diligence, this should be carefully evaluated with legal, corporate finance, and tax advisors.
Thought should be given to any unknown risks or liabilities and whether the selling shareholders need to be released from any obligations, such as personal guarantees. Depending on the business and the MBO team’s knowledge, our corporate team may be supported by our employment and commercial property teams to assist with the due diligence.
Beyond the main transaction documents and any funding arrangements, the new management team and Holdco shareholders must consider how they will work together. Bespoke articles of association and a shareholders’ agreement are usually essential.
Value to all
MBOs can be a rewarding way for executives to take control of their company, however it is crucial to understand the legal risks. Poorly managed transactions can derail the deal, exposing all parties to substantial risk and jeopardise the ongoing business’s future.
Long-term planning is vital for both the management team and exiting sellers. The management team should have time to transition into ownership roles, and any gaps in the team should be filled internally or with external hires. A strong team ensures the sellers achieve the best value and secure funding for the transaction.
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