MBO - guide and legal issues

A Management Buyout (MBO) can be a powerful way for a company’s existing management team to take control of the business they know best. However, navigating the legal, financial, and strategic complexities of an MBO requires expert guidance.

Whether you're a management team considering a buyout or a business owner exploring succession options, we’re here to help you achieve a smooth and successful transition.

Key legal issues with a management buy out

Key legal issues include structuring the deal, securing financing, negotiating contracts, conducting due diligence, and addressing potential conflicts of interest. Compliance with corporate governance, shareholder rights, and regulatory requirements is also crucial. Difficulties can arise in areas including :-

• Directors' duties - the management team must carefully manage their conflict of interest as both buyers and directors owing fiduciary duties to the company/shareholders. They need to be transparent about their position and may need to step back from certain board decisions.

• Information disclosure and access - ensuring fair disclosure of company information while protecting confidentiality, particularly if the MBO fails. Need proper NDAs and data room protocols.

• Warranty protection - management typically have deep knowledge of the business, so sellers often resist giving extensive warranties. Need to carefully negotiate warranty coverage and limitations.

• Financing structure - legal implications of different funding sources (debt vs equity), security arrangements, and personal guarantees. Need to ensure compliance with financial assistance rules if company assets are used as security.

• Employment/service agreements - need clear terms for management team's ongoing roles, including non-competes and good/bad leaver provisions in new shareholders' agreement.

Key legal documents & clauses

• Share Purchase Agreement - defines the purchase price, payment terms, warranties, and conditions for completion.

• Loan Agreements - outlines the terms of any debt financing obtained for the MBO.

• Shareholder Agreement (optional) - governs the relationship between the new shareholders (management team) and any remaining investors.

• Non-compete clauses - restricting previous owners from competing with the business.

• Earn-out provisions - linking part of the purchase price to future performance targets.

• Tax considerations - structuring the deal to minimise tax liabilities.

Funding an MBO

Typical options will include :-

• Debt financing - banks and other lenders often provide debt to finance part of the purchase price.

• Equity financing - private equity firms or other investors may provide equity investments.

• Management team contribution - the management team typically invests personal funds, demonstrating commitment and skin in the game.

What can go wrong with a management buy out?

Several key things can go wrong with a management buy out :-

• Financing failures - lenders pull out, debt terms become unworkable, or personal guarantees become too onerous for management to accept

• Valuation disputes - management team and sellers can't agree on price, especially if business performance changes during negotiations

• Management team splits - internal disagreements over roles, equity splits or strategy can fracture the buying group

• Due diligence reveals problems - unexpected liabilities or performance issues emerge that affect deal viability

• Employee/customer reaction - key staff or customers leave due to uncertainty, damaging business value

• Seller changes mind - particularly in family businesses, emotional attachment can lead to last-minute withdrawal

• Competition - rival buyers emerge during process, driving up price or creating uncertainty

The complexity and length of MBO processes means there are multiple points where deals can derail, making careful planning and risk management essential.