Exit Planning via a Management Buyout (MBO)

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, but typically this value is locked up within the business.

Despite the seemingly more positive economic outlook, the pandemic has made several business owners aware that this wealth is at risk. Particularly during a trading period where it is apparent, there are shortages of just about all key raw materials (be that physical materials or skilled employees) and the world supply chain is struggling to catch up with global demand.

Considering the above, certain businesses will typically be ‘passed to the next generation’ be that family or the next management team. Whereby we are 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 achieved by the business borrowing money to fund this 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 consideration 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 is deemed to be insufficient or lacking credibility, consideration should be given to bolstering this team ahead of an MBO, or an external candidate may likely need to be considered. The key to the above is to plan for an MBO in advance and bring in the required skill sets to enable you as a business owner to extract yourself seamlessly from the business.

Looking at funding for MBO’s, we are in a period with almost unprecedented levels of cash circulating in the economy. In the current climate, we have seen the High Street banks (in the main) pull back from funding in the SME sector as 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 as this is a relatively modest cost given the increased flexibility and increased amount of funding in total that these alternative funders can put into the market to fund MBO’s.

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 paid upfront. Deals are often structured to avoid overstretching the business’s finances. Most deals have an ‘up front’ payment and a ‘deferred’ element, where additional funds that are generated from the business’s ongoing activities are paid over a pre-agreed timeframe.

An MBO structure may also be optimised where a business owner perceives increased risk. One example may be for business owners to look at those valuable assets (typically a freehold property) that have some intrinsic value outside of the business, 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 for the management team to acquire this property at some stage in the future once the level of risk has been reduced.

Summary

In short, there are many drivers for a potential MBO transaction to be considered, they offer flexibility and a more collaborative approach rather than potentially more challenging disposal to a third party. A more rudimentary driver of MBO transactional activity is the continual rumors around increases to capital gains tax in successive budgets, meaning that individuals are looking to crystallise value at the current more modest rates of capital gains tax.

Whilst we cannot pretend to predict the future, it appears clear that capital gains tax rates are unlikely to come down in the near term, 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.

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