Management buyouts and why they can be a good idea

An owner manager works hard to build their company and wants to know that it will be in safe hands when the time comes to step back or retire. One option of course is to sell the company to a third party but that can mean that the company is absorbed into a larger organisation, losing its unique culture and risking a loss of valued employees.

In many cases, the best people to take over the running of the company are the management team, as they are familiar with the business, they can help maintain the company culture, and they will ensure continuity of leadership. However, they may not have the funds to buy the company shares.

A typical and well understood management buyout (MBO) structure, in a situation where the management team do not have sufficient funds to buy the whole target company, is through the use of a newly incorporated holding company. The MBO steps might be as follows:

  1. The management team set up a new company (Newco), which may have a nominal amount of share capital or they could use their available cash to subscribe for share capital. The number of shares to be issued to each team member would be agreed between them.
  2. Newco acquires the target company in exchange for a combination of cash, shares and loan notes.

Newco could obtain a bank loan or private equity funding to pay the cash consideration, or it could receive dividends from the target company and use those to repay loan notes from the vendor shareholders.

Often there will be restrictions on the new management shareholders receiving dividends from Newco until any loan notes are repaid.

The Newco structure discussed above allows for a lot of flexibility when deciding on shareholdings going forward and also allows the vendor shareholder to retain a small shareholding if not ready to completely walk away. The final MBO structure will depend on the vendor’s wishes, the management team, and how the purchase is to be financed.

Tax on the sale

If structured properly, the selling shareholder should be liable to pay capital gains tax on the sale of their shares, which will need to be paid by the 31 January following the tax year of the disposal. If the sale is likely to take place shortly before 5 April, they may wish to consider deferring the sale to the new tax year to delay the payment of tax by a year.

Provided the relevant conditions are met, the shareholder may be able to benefit from Business Asset Disposal Relief (previously Entrepreneurs’ Relief) on the sale, allowing a gain of up to £1m to be taxed at 10%. A further £1m of Business Asset Disposal Relief can be obtained by a shareholder transferring shares to his or her spouse prior to the sale. This sort of planning should be considered well in advance of an MBO, at least two years, to ensure that all relevant conditions for the relief are met.

The selling shareholder should be able to defer the payment of capital gains tax relating to consideration received as loan notes, although they may prefer to pay the tax in the year of disposal in order to benefit from Business Asset Disposal Relief.

It is usually advisable to apply for advance clearance from HMRC to ensure that the selling shareholder has certainty on the tax treatment of the disposal.

Newco would be liable to pay stamp duty at 0.5% on the value of the target company shares acquired.

Provided the transactions take place at market value and appropriate elections are put in place, there should be no employment income tax implications for the management team.

Could an MBO be right for your business?

If you are a business owner considering selling your business, an MBO may be a good option for you.  Of course, it is a big decision and it will be necessary to carefully consider the pros and cons. Please get in touch if you would like to find out more.