Management Buyouts (MBOs) – Introduction
As business owners approach retirement, planning the succession of their business becomes a crucial task.
While third-party sales or Employee Ownership Trusts (EOTs) are common routes, a Management Buyout (MBO) offers an efficient and attractive alternative, particularly when other options are impractical or undesirable.
What is an MBO?
A Management Buyout (MBO) occurs when a company’s management team collectively acquires a stake in or the entirety of the company. This strategy is often employed when:
- The company is managed by a strong and capable team.
- The company has a solid profit record.
- The management team can leverage sufficient financing, or the vendor trusts the business to generate necessary returns to fund their exit.
MBOs are especially suitable for family businesses where there’s an emotional investment in ensuring the well-being of employees and stakeholders during the succession process.
Benefits of an MBO
Opting for an MBO provides several advantages:
- Profitable Exit: Allows business owners to exit profitably in a market with limited third-party buyers.
- Employee and Stakeholder Assurance: Offers more certainty and comfort compared to a third-party sale.
- Lower Professional Fees: Typically incurs lower transaction costs than a third-party sale.
- Flexibility: Lacks the rigid conditions often associated with EOTs.
Potential Risks of an MBO
Despite its benefits, an MBO carries potential risks:
- Incentivization Issues: If structured incorrectly, the management team may lack sufficient incentives to drive the business and generate necessary profits.
- Internal Friction: Differences in management team members’ willingness to become owners can cause friction.
- Longer Earn-Out Periods: Depending on the financing method, earn-out periods may be longer than those in a third-party sale.
Funding the Exit Value
Several options exist for the management team to finance the exit value:
- Private Funding: Using personal funds, including tax-efficient options like Self-Invested Personal Pensions (SIPPs) and Small Self-Administered Schemes (SSASs).
- Debt Financing: While commercial lenders may not offer facilities, private debt funds can provide fixed-term loans.
- Private Equity (PE) Funds: PE funds often subscribe for shares alongside the management team and provide debt financing. Management is typically required to contribute a meaningful portion of capital or undergo a vesting period for their shares.
- Asset Leveraging: The management team can borrow against the company’s real estate or debtors if feasible.
- Vendor Financing: The seller may leave a portion of the exit value on deferred terms, recouping this value from business profits over several years.
Tax Implications
General
Tax implications of an MBO can vary significantly based on transaction structure. Key areas to consider include:
For Sellers
- Achieving capital gains tax treatment instead of income tax treatment.
- Utilizing available tax reliefs, such as Business Asset Disposal Relief.
- Deferring liabilities in line with deferred terms or ensuring sufficient upfront liquidity.
- Exploring wider tax opportunities, such as using a trust for family inheritance tax planning before the sale.
For Ongoing Shareholders:
- Avoiding tax issues for non-exiting owners during the transaction.
For New Shareholders:
- Qualifying for relevant tax reliefs where applicable.
Early and expert tax advice is essential to navigate these complexities.
Key Considerations in the MBO Process
Each MBO is unique and requires tailored advice and direction. Common themes to consider include:
- Forecasting: Accurate forecasting, tested and validated, is crucial.
- Independent Advice: Both sides should seek independent legal and tax advice.
- Formal Valuation: Often required for tax purposes, even if not for commercial purposes.
- HMRC Submissions: Necessary to obtain relevant tax clearances.
- Due Diligence: Management must conduct thorough due diligence to ensure comfort with the company’s reporting.
Funding Covenants: Be aware of ongoing covenants, restrictions, or obligations tied to funding options and their implications if not met.
Management Buyouts – Conclusion
An MBO offers a strategic succession option with several benefits. However, like all successful succession planning, it requires careful planning, expert advice, and thorough due diligence to ensure a smooth and successful transition.
Final thoughts
If you have any queries about this article on Management Buyouts (“MBOs”), or other UK tax matters, then please get in touch.