What is the Management Buyout Process?

How does a Management Buyout work? - Early stage considerations for the Management Buyout (MBO) team

Are you part of management in a private company contemplating a buyout of the company’s owners? If so, you may find this summary useful.

In this article, Matthew Fretten outlines considerations for the MBO team at the outset, up to and including the preliminary agreements to be entered into, before proceeding with the main buyout transaction.

Funding and Legal Advice for MBOs

Suggested first step for your MBO team is to appoint advisers to:

• advise on costs of and assist with securing the appropriate level of any external funding needed
• provide legal advice

Preparing a Business Plan

A business plan is needed to assist with procuring finance. The plan will set out the business opportunity your MBO team envisages and should cover aspects such as: 

• the business proposition and the amount of funding required a brief description of the business’ industry sector, products/services, key customers and suppliers
• a financial summary of past performance and future projections, the latter to include information on key assumptions and show the effect of significant changes to the business in any key variables
• identifying and substantiating funding requirements (supported by cash flow projections)
• provide information about the management team

Finding Funding for the Management Buyout

Your MBO team need to understand the issues which will concern a potential private equity provider which may include: 

• management and sector expertise
• size of transaction, length of investment and stage of business at time investment is applied for
• geographic location

Legal advisers for MBOs

The various parties involved in the MBO will need legal advisers, the usual parties being:

• MBO team  
• private equity provider  
• newco (the MBO team’s newly formed company used as the purchasing entity)
• debt providers (senior and junior)

Confidentiality   

Confidentiality issues will arise throughout the transaction because of the need for management to disclose certain confidential information about the target business to third parties (such as private equity providers).

Employment contracts

It is important to review management’s contracts of employment to ensure that there are no contractual provisions prohibiting management from being involved in the buyout. 

Structure of the Management Buyout

There are certain issues, which relate particularly to buyouts that may affect the decision whether to structure the acquisition of target as an acquisition of shares or assets. 

What is the difference between share or asset purchase?

On an asset purchase, the buyer can decide which assets and liabilities it acquires whereas, on a share purchase, generally speaking, the buyer takes on all assets and liabilities.

Buyouts should be structured as an asset purchase if the business is a division of the selling company or where certain assets or employees are used in other parts of the seller’s group. There are other considerations, which govern the choice of structure, such as tax or other liabilities in the target company, availability and level of warranty cover, Stamp Duty, need for third party consents.

Preliminary agreements in a MBO

Heads of terms (Heads) with Seller

Heads set out the principal terms upon which the purchase of the business will proceed.  Heads should be entered into before commencing the process of due diligence, disclosure and the drafting and negotiation of the agreement acquiring the business. 

Principal parties to the Heads are the MBO team and the seller. Newco will probably not yet be formed. If the seller is a subsidiary of a group holding company, then the holding company should also be a signatory. Heads are generally made “subject to contract” and expressed not to be legally binding.

List of areas that Heads of Terms will deal with: 

• price and payment
• principal assumptions on which the transaction will proceed
• conditions attaching to the transaction
• exclusivity
• costs and a costs indemnity
• timing and preparation of documentation.

Legal input is strongly recommended when the Heads are negotiated to ensure that the agreement covers all relevant areas, it is correctly drafted from a legal perspective and the MBO team does not make any concessions which has the effect of tying their hands in future negotiations. 

Heads of terms with private equity provider

Heads are also used to set out the principal terms upon which the private equity provider is prepared to invest in Newco.

Each private equity provider has its own approach and tend to take the form of either an offer letter or an equity term sheet.  The Heads should be expressed to be “subject to contract” and not legally binding.

Management should negotiate the Heads with great care, ensuring these cover, where applicable, items such as the following: 

• terms of investment in Newco and funding structure
• conditions precedent
• institutional vetoes
• ratchets (to incentivise management)
• private equity provider’s board representative
• provision of information
• warranties
• fees and costs
• timing
• exclusivity between management and the private equity provider
• good leaver/bad leaver provisions and drag along provisions

Exclusivity agreement

Exclusivity arrangements between a buyer and a seller are often included in the Heads between Newco and the seller but can also be contained in a separate agreement. From management’s perspective, in a buyout situation, exclusivity will confirm their “employers’” intention to sell to them and ensures (for a limited period) that trade buyers are excluded from the process.

For some sellers, the hurdle of agreeing to sell to management can be difficult to overcome and exclusivity is tactically important as part of the negotiation process. 

The key features in any exclusivity agreement in an MBO are: 

• terms of investment in Newco and funding structure
• conditions precedent
• institutional vetoes
• ratchets (to incentivise management)
• private equity provider’s board representative
• provision of information
• warranties
• fees and costs
• timing
• exclusivity between management and the private equity provider
• good leaver/bad leaver provisions and drag along provisions

Confidentiality agreement

At the outset of negotiating an acquisition, whether a buyout or otherwise, it is common practice for a seller to require a buyer to enter into a confidentiality agreement, restricting the disclosure of information of a confidential nature made available to Newco and its advisers.

In a Management Buyout, the parties who need to be restricted may be different. If the managers are employed in the target business, they will already be subject to confidentiality restriction, either under their service contracts or by virtue of the common law duty of confidentiality.

Frettens: Management Buyout Solicitors in Bournemouth, Poole, Christchurch, Ringwood

Real People. Well-rounded advice. Brighter outlooks.

Matthew Fretten is the Managing Partner and a qualified solicitor in our Corporate and Commercial Team. He is perfectly placed to provide legal advice to you and your business in relation to business transactional and contract matters.

For a free initial consultation at our Christchurch or Ringwood offices with a member of our Corporate and Commercial Team, call us on 01202 499255 or click here.