Important legal considerations in a management buyout

So, you are part of a management team within a limited company and contemplating acquiring the company from its current owners. This is known as a ‘management buyout’ (MBO).

Solicitor Justine Harris Hughes from WHN’s corporate and commercial team outlines the process and important considerations when undertaking an MBO, to ensure the process goes smoothly and meets your expectations.

If you are considering undertaking an MBO as a management team, a comprehensive understanding of the business offers you a greater advantage. Having an existing relationship with the current owners, suppliers and customers of the business can translate into a smoother and quicker transaction than where a business purchase is entirely ‘arms-length’. However, that is by no means guaranteed and it is essential not to inadvertently ‘short-cut’ key stages of the process.

Before the legal work begins, several key matters need to be addressed. If you are undertaking the MBO as a team, is the whole team sufficiently motivated and skilled to achieve the growth and development objectives behind the MBO? Will you all work well together as a team, through the challenges that will undoubtedly come?

If you are embarking on the venture as an individual, are you confident that the rest of the team will come together to support you in your ambitions?

Once you are confident that an MBO is the right option for you (individually or as a team) there is a range of legal process matters to consider.

Structuring the deal

The first, fundamental, decision is how the management buyout will be structured – ideally, as far as possible, to meet the (sometimes conflicting) needs and expectations of all parties involved.

In terms of the method by which the business will be acquired, the two main options are:

• A share purchase, where the out-going owners sell their shares in the company to the buyer
• An asset purchase, where the limited company itself sells all the assets of the business as a going concern to the buyer.
• Typically, an MBO will be a share purchase, where the management team will incorporate a new limited company in which they all have an equal shareholding.

This ‘new company’ will buy all the shares in the business being acquired – in the process acquiring all the assets, and crucially also all the liabilities, of the company being acquired.

However, this is not the only option. Each individual team member could buy a certain percentage of the shares being sold, or if the management team already hold some shares, there is the option (subject to certain criteria) for the company itself to buy-back shares from the existing owners, leaving only the management team as the remaining shareholders after completion.

Alternatively, the MBO could be undertaken as an asset purchase – for example where only one part of a business is to be sold, giving the management team control over the specific assets and liabilities they will acquire.

The structure of an MBO will also be influenced by considerations such as:

• The differing tax implications for the parties with each approach
  - The obligations and liabilities within the company being acquired
  - The differing requirements for any third-party consents
  - Funding arrangements
• If there is deferred consideration, what security (if any) will be required.
  The negotiating strength of the parties will also come into play and balancing the sometimes-competing interests will be vital for the overall success of the transaction.

Due diligence

A reduced need for due diligence may be required for an MBO due to the existing knowledge of the business that the management team has. Nevertheless, it is essential to consider the areas in which the team may lack the required knowledge, and to undertake a sufficiently detailed due diligence exercise.

This is particularly important when carrying out a share purchase, where the buyer will take ownership of the company not only with the benefit of its assets and rights, but crucially also subject to all its liabilities and obligations.

Legal documentation

Comprehensive, well-drafted documentation that addresses all the issues and concerns of the parties is essential to a successful and seamless MBO process. Key elements of the main contract documentation will include:

Financial matters – including the price and payment terms, and provisions for post-completion accounts.
Warranties – these are a series of statements of fact about the company from the sellers to the buyers, to give contractual assurance, and usually cover all aspects of the company’s affairs.  If a warranty is breached, a buyer may make a claim for their financial losses incurred as a result.
Indemnities – these also provide contract assurance to the buyers, but in this case by requiring the sellers of the company to compensate the buyer on a pound for pound basis for specific ongoing or future liabilities in the company.
Restrictive covenants – In many cases the out-going owners will be retiring. However, that is not always the case and negotiating restrictive covenants may be required.

Ancillary documents required for an MBO

In addition, a full suite of ancillary documents will need to be put in place to address such matters as:

• Contracts for service or employment contracts if the out-going owners are intending to work for the company after completion
• Resignation of the owners as directors, and consent to the appointment of new directors
• Notifications from all parties regarding the ‘persons with significant control’
  Waivers of pre-emption rights
• Stock transfer forms (in the case of a share deal) and indemnities for any share certificates the owners no longer hold
• Powers of attorney
• Board meeting minutes for the company being sold, and the buyer company, to authorise all aspects of the transaction and documentation.

Keeping the business going during an MBO

Until the deal is done, the management team who may potentially become the owners of the business are first and foremost, still employees.

Transitioning from management to business owners is not always straightforward, and a poorly managed or abandoned MBO can adversely affect business operations and relationships.

The MBO process can be prolonged and demanding, placing considerable pressure on management teams, and the other employees within the business.

With an asset purchase, there are also the requirements of the Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE) to consider for all employees, and the potentially unsettling effects such a process can have on the whole workforce.

Post-completion of an MBO

Once complete, it is essential to ensure that all post-completion matters are promptly dealt with – including filing all relevant forms and documents at Companies House and updating all the company’s statutory books.

Other changes agreed during the process will also need to be implemented straight away, such as new bank mandates and informing clients and suppliers.

Justine specialises in corporate matters including company incorporation, share sales and buybacks, and corporate property work.  

If you are an individual or part of a business management team considering a management buyout and would like to discuss the above in more detail, please contact Justine on 0161 761 4611 or by email at [email protected]