Exit Planning – Management Buyout

This is Part 1 of the Sixth Step in our series on planning for your exit.  Last month we considered the pros and cons of a trade sale as a route to retirement. This would mean selling to another company, possibly a competitor, and not a financial buyer or your management team. Most people assume this will be their best option when they decide to move on. However, this route presents some challenges; we highlighted some of the pitfalls in our January newsletter.

This month we want to introduce you to an exciting new concept: it is called the Vendor-Funded Management Buy-out.  In next month’s newsletter we will tell you about the three key areas to consider with such an MBO and how to protect your own interests as the owner-manager.

Experience has shown us how powerful this process can be as a tool for owner-managers like you to align the interests of owners and managers in order to prepare a company for a mutually beneficial change of ownership.

If you would like further information on selling your company and management buyouts please click here.

James Hunt and the team at
Everyman Legal


Preparing your company for a successful exit with a management buyout

You and your advisers may have some misconceptions about a management buy-out.  These are some of the most commonly expressed reservations:

The management team have little or no money so they could they not possibly buy the company: this is dealt with below.

The management team will need to appoint their own advisers and raise the money for the buyout.  This is unlikely to work with a small owner-managed company.  It is true for large MBOs backed by private equity investors who are unlikely to be interested in a company which required an investment of less than £10m or even more.

Encouraging your management to consider a management buyout may lead to divided loyalties and conflicts of interest.  This is undoubtedly a risk but not if you and your advisers manage the process effectively.  Indeed an MBO can be a great motivator for the right team.  On the other hand the fear that you may do nothing or delay indefinitely (or worse still sell to a trade buyer) may be highly unsettling.  Your best prospective team members may leave (or perhaps not even join you!) if you are unable to tell them a story that they find exciting and compelling.

What is the Vendor‑Funded Management Buyout?

The technique most suited to smaller owner-managed companies is what we call the Vendor‑Funded MBO.  In this structure you as owners become your own private equity house and banker.

An initial point to make is that this technique is only appropriate if you have a well-developed management team.  You do not want a complex structure that leaves you with the prime responsibility of ownership:  the monkey on your back as someone once remarked to me.

Provided you have that team in place how does this work?

The MBO team will form a new company which will acquire your company for a combination of upfront cash (perhaps your company’s cash reserves), together with a deferred cash payment and a residual equity stake for you.  If the cash payment is a full price compared with what you would get on a trade sale this residual shareholding may be regarded as a free equity ride: a participation in the value of future growth of the company after you have been paid a good price in cash.  You may regard this as an extra reward for the fact that most of the cash consideration is going to be paid to you over a period of time.  This increases the risk for you so it is only fair that you have the extra reward in the continuing shareholding.

Newco will pay the deferred cash out of your company’s future cash flow.  This will enable you (as if by magic) to take cash out of your own company paying just 10% tax (after entrepreneur’s relief from CGT) instead of dividends liable to tax at over 30%.

So what’s the catch?

You may well think this is all too good to be true, particularly if you are able to name your price to an MBO team. There are three areas to watch out for:

  1. setting the right price;
  2. getting the necessary tax clearances; and
  3. protecting your own interests.

We will tell you about each of these areas in detail in next month’s newsletter.

Hints and Tips

  • Ensure you have appointed a lead adviser to guide you so that you can develop a plan for your exit;
  • Make time to undertake this planning well before the date that you have decided you wish to take a less active role;
  • Make sure that you use experienced legal advisers who can make sure that you retain the flexibility to sell to a trade buyer if the V-F MBO becomes impossible or impractical to execute; and
  • Appoint a non-executive director or chairman and consider incentivising this person with shares or a share option.  The right person will help you and your team grow your business.