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The five golden rules of management buyouts

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Management buyouts (MBOs) are a good way to plan for succession when owners of a business are looking to take a step back, giving greater continuity to the business.

For business owners in that position, here are some key issues to consider before, during, and after an MBO.

Preparation, preparation, preparation

MBOs can cause significant upheaval to a business, and anything which can be done to streamline the process is a bonus. Ideally, owners should be grooming their management team leading up to an MBO, from any time up to five years in advance. This would involve identifying relevant people with appropriate skills to take on the business, integrating them into the management of the business, and giving them significant exposure to the key contacts of the business, to ensure a smooth handover.

Financial Planning

The key to a clean MBO is getting the financials right. The exiting owners should consider what value they want to extract from the business, and how they want to get it, for example, a lump sum, an earn-out period, or other staged payments. The management team should consider what they are willing to pay and how this is going to be funded (debt finance, venture capital, private equity). Owners and managers should work together in this regard to present a united front to any potential funder, and a robust business plan is key to winning the support of those who hold the purse strings.

Structure

It is essential to get the structure of the buyout right to suit all parties. Typically a new company will be formed, owned by the management team, which will purchase the shares in the target company. Depending on the funding arrangements, in addition to the management team, there may well be investor directors involved who will want a large say in the running of the business until they have realised a return on their investment. The interests of the owners, the management team, the investors and the lenders will all need to be carefully balanced to ensure success.

Legals

Well drafted and appropriate documentation is essential to ensure the MBO goes off without a hitch. Both the owners and the management team (in addition to any external investors) will need to be separately represented. While the transaction should be more ‘friendly’ than a trade sale, there are still conflicting areas which will require independent advice to be sought. Given the management’s prior involvement in the business, warranties and indemnities are usually kept to a minimum. However, it is important to note that where third party investors are involved, the management team may well be requested to give a full suite of warranties to satisfy them.

After the sale

If the owners have managed to secure the full consideration, they will be able to enjoy their retirement in peace. However, typically there will be a staged exit, with consideration potentially linked to ongoing performance. All parties will need to pull together to ensure the ongoing success of the business. The first goal is to ensure all equity and debt finance used to fund the transaction is repaid, and a full exit is ensured, either by an onward sale to a third party, a flotation, or simply by the management team taking up the reins of the business free and clear and moving it on to the next level.

If you would like legal advice on any aspect of mergers and acquisitions, please contact David Filmer on 01772 258321.


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