Following the impact of Covid-19, many business owners are beginning to proactively consider their future succession plans. The pandemic is one of those seismic shocks that make business owners stand back and consider their wider ‘life’ position. A business will be the most valuable part of an entrepreneur’s overall wealth. Although this value is typically tied up within the business.
Despite the seemingly positive economic outlook, the pandemic has made several business owners aware that this wealth is at risk. Particularly during a trading period where there are shortages of just about all key raw materials. Be that physical materials or skilled employees. The world supply chain is struggling to catch up with global demand. That’s where a Management Buyout (MBO) comes in.
Considering the above, certain businesses will typically ‘pass over to the next generation’. Be that family or the next management team. Whereby we’re seeing business owners focusing on ‘legacy’ with a desire to see their business and its employees succeed and flourish in the future. This desire would suit a Management Buyout (“MBO”).
What is a Management Buyout?
A Management Buy-Out or more commonly known as MBO is a transaction whereby a group of people within the current management team of a business buy out a majority of all the shares from existing shareholders. This is often achievable when the business borrows money to fund the purchase. As the existing management team already knows the business well, this is often the smoothest type of succession and typically will offer quicker and easier completion.
Considering an MBO?
When considering an MBO thought must be given to the funding landscape and the key individuals within the existing management team. The key element to any successful MBO is the quality of the management team supporting the current business owner. If this management team is incomplete or does not have credibility, it is likely to be a non-starter.
Where a management team may appear to be insufficient or lacking credibility, thought should be put into to bolstering this team ahead of an MBO. Sometimes an external candidate may be an option to consider. The key to the above is to plan for an MBO in advance. This means bringing in the required skill sets to enable you as a business owner to seamlessly extract yourself.
Funding for MBOs
Looking at funding for MBO’s, we are in a period with almost unprecedented levels of cash circulating in the economy. We have seen the High Street banks (in the main) pull back from funding in the SME sector. Meanwhile, they look to understand their balance sheet position on the back of unparalleled lending through the pandemic.
This has also however provided an opportunity for the so-called ‘alternative’ funders to capitalise on this opportunity to become the mainstream funding source for the changing needs within the SMEs sector. The impact is a high availability of funding with more flexible funding structures than would typically be available historically, however, the underlying price point has increased.
This price point increase should not overly concern business owners looking to structure a transaction. This is a relatively modest cost considering the increase in flexibility and higher amount of funding in total that these alternative funders can put into the market to fund MBO’s.
Concerns for MBO teams
A concern for many MBO teams can be the potential debt burden. However, it’s important to point out that it’s unusual for the full share purchase amount to be complete upfront. Deals are often feature a structure to avoid overstretching the business’s finances. Most deals have an ‘up front’ payment and a ‘deferred’ element. This means additional funds that generate from the business’ ongoing activities are given over a mutual timeframe.
An MBO structure may also optimise where a business owner perceives higher risks. For example, business owners may look at valuable assets (typically a freehold property) that have intrinsic value outside of the business. This is in addition to trading value, and to potentially extract that freehold property into personal ownership to ring-fence this asset to protect it from a failed MBO transaction.
This would leave the management team to acquire the trading entity at a lower valuation and potentially de-risk both parties. There would be no reason why both parties could not enter into an option agreement around the freehold property. This allows the management team to acquire this property in the future once there is a reduction in risk level.
In other words, there are many drivers for a potential MBO transaction that need considering. Firstly, they offer flexibility and a more collaborative approach rather than potentially more challenging disposal to a third party. A rudimentary driver of MBO transactional activity is the continual rumors around increases to capital gains tax in successive budgets. This suggests that individuals are looking to crystallise value at the current more modest rates of capital gains tax.
Whilst we cannot predict the future, it’s clear that capital gains tax rates are unlikely to come down any time soon. They may stay the same, but at some stage in the future are more than likely to increase.
If you believe that an MBO could be right for you, please don’t hesitate to get in touch and contact the PMD Structured Finance Solutions team. We have a wide network of professional advisors who would be happy to discuss your unique circumstances on a non-obligatory basis.