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What is a management buyout or MBO?

28 August 2020
Mark Friend
Payroll, People, Raising Finance, Selling a Business

As your business comes to maturity thoughts often move to retirement and if possible extracting value from the business to compensate you for the years of hard work in building a successful business.

Usually a business owner has four clear choices:

  1. The business is not that saleable. The business owner is the business and without them the business has little, if any, value. In that situation the business owner simply has to look at the most tax efficient way to realise all the base assets in the business.
  2. The business is a family business. The business owner often simply gifts the company shares to the next generation.
  3. The business is put up for sale on the open market.
  4. The business is sold to the company’s management team through a management buyout.

In this blog I want to look at management buyouts or MBOs. For many business owners selling to your management team could be an obvious and highly attractive option.

We have prepared a video on management buyouts:

 

Management buyout thumbnail

 

For the seller the advantages include built in confidentiality and ease because you know your team, plus maybe the company was your baby and selling to your management team just feels right for you.

If you are the management team then the MBO offers a unique opportunity to acquire the business you work in; a business you know and understand, where the return on your investment is likely to be huge and where to an extent you control the risk.

As long as both parties are flexible then a great deal can often be made.

The deal could involve buying either the shares in the company or the assets.

A straightforward purchase of the shares might be possible. But in practice what happens if the management team need to raise say £1m for the purchase?

In this situation there are two elements that need to be considered:

Finance

Firstly the management team might not have all the finance required themselves.

The management team will have to raise some funds personally called “hurt money” but the rest will usually be raised from the banks.

In addition in most cases we have dealt with the seller enters into an agreement to help with financing over an agreed period of time.

Tax efficiency

The second element is tax efficiency. Structuring the deal to ensure the seller gets Entrepreneurs’ Relief whilst minimising the tax implications for the management team is key.

Typically most deals involve the management team setting up a new company which buys the target company.

The shares are bought by “Newco” using the cash introduced by the management team, monies from the banks and finance from the seller.

The share price paid can be fixed from the outset, or be based on future levels of profitability or turnover and spread over a term agreeable to all parties. A short-term consultancy agreement with the seller may be needed to ensure a smooth transition.

Here is an example of a management buyout.

Tom wants to sell his business. He has it valued at £2m. The business generates an annual profit of £500K per year. Ideally he wants to sell the business to his management team. The management team  Jane, Mary and John are keen to buy the company but they will struggle to raise £2m.  They talk to their advisors and after negotiation a deal is struck.

Tom will be paid £200,000 on completion of the deal, £300,000 shortly afterwards and then £300,000 a year for the next 5 years (paid out annually on the anniversary date of completion).

Jane, Mary and John raise £200K and through the bank are able to raise another £300K secured from assets held within the business or from personal assets.

The management team form “Newco” which purchases the shares from Tom for £2m. Jane, Mary and John raise £200K and pay this into “Newco”. This money is used to complete the deal. Monies from the bank and from profits generated within the target company are passed up to “Newco” often as dividends to then meet the remaining payments. Over the next 5 years “Newco” pays off the remaining debt to Tom.

Tom will need to declare the share disposal on his tax return and pay capital gains tax on the capital gain on the full amount of the agreed purchase price, even though he has agreed to receive the money in instalments. However he should be able to claim Entrepreneurs’ Relief (provided he meets the criteria to claim the relief) so that the tax is payable at 10% rather than 20%.

Read more about Entrepreneurs’ Relief here.

Summary

Over the years we have dealt with many MBOs, acting for the vendor or the purchaser. We specialise mainly with smaller businesses and recently completed a £3m MBO.

We can assist with due diligence, the structure of the deal and review the accounting and tax implications of the deal. We can obtain the necessary clearances and liaise with the solicitors to ensure that the deal meets everyone’s expectations.

Getting the right professional advice is important when doing a management buyout and we strongly recommend that you seek professional advice, whether you are selling to your management team or whether you are buying.

MBOs are flexible and a great way for the management team to take the business over with ease and minimal disruption.

Please call us if you need expert advice.

The content in this blog is correct as at 28/08/2020. See terms and conditions.

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