Management buyouts: why structure matters from the start

That can be particularly attractive where a founder is less comfortable with the idea of selling to a competitor or external investor whose priorities may be different. An MBO can also provide the founder with a strong financial outcome, potentially structured in a tax-efficient way with the right tax advice.
The buyer is a team that already knows the business, understands its strengths and is invested in its future success. That familiarity can make the process feel more straightforward than a sale to an external purchaser. It is often an advantage, but it can also lead the parties to underplay the need for process, documentation and independent advice. In practice, MBOs raise many of their own challenges, particularly around valuation, funding, governance and deal structure.

Why founders consider an MBO

For many founders, an MBO can feel like a particularly attractive way to step away from a business they have spent years building.

Rather than selling to an unknown third party, ownership passes to people who already understand the business, its customers, its culture and the way it operates. That can give founders greater confidence that the business will continue in a way that feels familiar, while also giving key members of the management team the opportunity to take the next step and benefit from the value they have helped create.

There can be a strong sense of continuity too. Employees, customers and suppliers may already know and trust the management team, which can make the transition feel less disruptive than a sale to an external buyer. For some founders, that continuity and the ability to preserve the character of the business can be just as important as the financial outcome.

An MBO can also offer flexibility around the founder’s own exit. Some founders want to step away completely, while others prefer a more gradual transition, perhaps remaining involved for a period, retaining a minority interest or receiving part of the consideration over time. With the right structure and appropriate tax advice, an MBO can still deliver a strong financial outcome while supporting a smooth handover.

It is not necessarily the right route for every business. The management team needs to be capable of taking the business forward, the funding has to work and the parties need to be realistic about valuation, risk and the founder’s ongoing involvement. These are all issues that should be considered early, before the parties become too committed to a particular structure.

Getting the funding structure right from the start

Most MBOs are funded through a combination of debt, equity and, often, some form of deferred consideration from the business. The proportions vary enormously depending on the business, the transaction value and what funders are prepared to support. What matters legally is that the funding structure is understood and documented properly before it is committed to.
How the deal is funded will influence almost every part of the transaction, including the documents required, the security funders may ask for, the level of risk retained by the seller and how future returns are shared between the management team and any investors. 

Where institutional funding is involved, whether from a private equity house, a specialist MBO lender or otherwise, funders will have their own requirements around security, reporting and governance. These are not always negotiable, and they can shape the transaction in ways that are not immediately obvious from a term sheet. Understanding what is being agreed to, and what obligations it creates, is legal work that needs to happen in parallel with the financial structuring rather than after it.

Shareholders agreements: what happens after the deal

The shareholders agreement is one of the most important documents in any MBO and one of the most commonly underestimated. In the excitement of getting a deal over the line, detailed negotiation of what happens between shareholders post-completion can feel like a distraction.

An MBO typically involves a management team with different levels of seniority, contribution and equity stake, often alongside an institutional investor or the exiting owner retaining a minority position. The shareholders agreement needs to reflect that reality and to address, clearly and in advance, the questions that will inevitably arise once the deal is done.

Which decisions require unanimous or super-majority consent, and which can be decided by a simple majority (or by the directors)? What happens if a member of the management team leaves, voluntarily or otherwise - do they retain their shares, and on what terms? How are future funding rounds handled, and what dilution protections exist? What does an exit look like, and who controls the timing and process?

These are common situations that arise in almost every MBO at some point, and the time to answer them is before they become issues between people with competing interests. A shareholders agreement negotiated under the pressure of a live dispute is a much harder document to get right than one agreed when everyone is aligned and motivated to complete.

Vendor loan notes

Vendor loan notes - where the seller leaves some of the consideration in the business as a form of deferred debt - are a common feature of MBOs, particularly where the purchase price exceeds what conventional funding will support or where the seller has tax reasons to spread the receipt of proceeds.

From a legal perspective, the key issues are straightforward but worth addressing carefully. The loan note instrument needs to be properly drafted, setting out the interest rate, repayment schedule and what happens in the event of default. The relationship between the vendor loan note and any senior debt in the funding structure needs to be understood - most institutional lenders will require the vendor loan to rank behind their own debt, which affects when and how the seller gets repaid. Any security needs to be agreed clearly, so the seller, management team and senior lender all understand where they stand if the business later comes under financial pressure.

The practical point is that a vendor loan note represents a continuing financial relationship between the seller and the business after completion. The seller has an interest in the business performing well enough to service the debt. That creates a dynamic that is worth acknowledging and managing, both through the loan note terms themselves and through whatever ongoing relationship exists between the seller and the new management team.

Governance after the buyout

One of the most significant changes in any MBO is the shift in how the business is run. A founder who has led the company for years, making decisions quickly and informally, is typically replaced by a management team that may have institutional investors with board representation, reporting requirements and specific consent thresholds for major decisions.

That transition needs to be managed deliberately. Board composition, decision-making authority, reserved matters and reporting obligations should all be documented and understood before the transaction completes - not worked out in the weeks afterwards when everyone is trying to run the business.

Where private equity or another institutional investor is involved, they will typically have clear views on governance from the outset. Their requirements will be reflected in the shareholders agreement and the articles of association. The management team should take those documents seriously as operational documents, not just legal ones, because they will govern how the business is run from day one.

For MBOs without institutional involvement, governance is sometimes treated more loosely which is understandable but can create problems as the business grows or if relationships within the management team become strained. 

Starting early

In our experience, timing is often what determines whether these issues remain manageable or become deal problems. The legal structure of an MBO is not something that can be finalised at the last minute without consequences - for the management team's tax position, for the allocation of risk between the parties, and for how the business operates once the deal is done.

If legal advisers are involved early, working alongside other advisers rather than being brought in once the commercial framework is already fixed and some of the most important decisions have already been made, it puts the team in a much stronger position to complete successfully and operate confidently afterwards. 

A management buyout can be an effective succession route for founders and a significant opportunity for management teams, but the structure needs to be carefully considered from the outset. Funding, valuation, governance, deferred consideration and post-completion control all need to work commercially as well as legally.

If you are a founder, management team or adviser considering an MBO, our Corporate team can help you understand the options, identify the issues that need to be addressed early and put the right legal structure in place. Contact us to discuss your options.