A management buyout, or MBO, is the purchase of all or part of a company by its existing management team. The purchase price is typically funded through personal contributions by the management team together with commercial finance, as explored in further detail below.
Routes to financing an MBO
This involves members of the management team taking on debt personally in the form of one or several loans. Loan providers will typically require security in the form of charges over personal assets such as their homes, pensions and any other valuable assets. As the personal risk for the management team is high and the value of the security for loan providers is limited, the majority of lending will be achieved through commercial finance.
Business loans take the form of a company debt which the company will be obliged to repay over a fixed period of time. Loan providers will typically look to take security for their loan in the form of charges over the company’s assets such as property and plant and machinery.
Private equity investors provide finance to the company in exchange for shares with a view to realising a return as the company (and the value of their shares) grows. It is worth bearing in mind that private equity investors will be looking to exit the business and realise their investment in a relatively short time frame (no more than three to five years usually). Provision may have to be made for replacement funds should the management team wish to continue with the business beyond this time.
Mezzanine finance combines debt and equity financing in the form of a business loan which converts to equity if the loan is not repaid. It is often used in MBOs as a top-up finance to the main debt and equity finance elements.
Alternative sources of finance may be available from time to time, for example government-backed schemes such as the Wales Management Succession Fund. This fund provides loans and equity investments to help management teams buy Welsh businesses when the current owners retire or sell up.
The owners of the company will often support the management team to achieve the purchase price by deferring consideration due to them from the sale. This is typically done in the form of loan notes which the management team will repay over a period of time.
Can a member of management use their own money to fund their stake in an MBO?
The personal contribution of management is fundamental to an MBO and not only proves to lenders and investors that the members of the team have ‘skin in the game’ but may also be a requirement of any funding. The contribution may come from various sources such as personal savings, personal loans or the sale of assets. The amount of the contribution typically represents around six to 12 months’ wages.
By way of example, if a management team of five needed to raise one million pounds to buy the company, they may each contribute £100,000 personally, borrow £400,000 by way of business loan and the additional £100,000 may be injected via a mezzanine finance loan.
What tax consequences are there to consider?
An MBO is a complicated transaction and structuring the deal incorrectly can have detrimental tax consequences. Seeking legal and tax advice at an early stage is crucial to getting it right for the sellers, the management team and the company.
The key tax considerations for the management team will be whether the purchased shares fall within the income tax or capital gains tax regime. If within the capital gains tax regime, they will need to consider the availability of business asset disposal relief (formerly entrepreneur’s relief). The availability of income tax relief for interest on any loans used to purchase the shares, should also be established.
The key tax considerations for the sellers will be the availability of business asset disposal relief, as this will allow the sellers to increase the cash that they can take out of the business on a sale.
If you are considering going down the MBO route then legal, financial and tax advice at an early stage is essential to ensure you get the deal right. MBOs are complex and involve a lot of parties to the transaction with large amounts of money and risk involved. Please get in touch with our experienced corporate team if you have any questions about MBOs, MBO financing or any related tax queries.