Special Report: Taking you by the hand

Finding the right experts to lead you through the MBO labyrinth

When the itch strikes to own your business, which option offers the most ‘knowns’ – a start-up or a management buy-out of the company you currently work for?

“I think the MBO is probably your best bet,” said chartered accountant Neil Denniss (pictured), partner at Bespoke Tax in Cheltenham. “The vendor and the buyer know each other, warts and all – they know if they’re honest or not.”

Denniss continues: “The MBO is a lower risk from every business perspective because there’s a consistency of management team; they haven’t got to get to know the business – they jump in, they’re already running. From that perspective, it’s a darn sight easier.”

When Abatec Recruitment sought expert guidance for their MBO last year, Neil Denniss was their choice to lead them through the labyrinth. In Q1 2021 alone, Denniss has been involved in £144m worth of transaction.

And as straightforward as an MBO might seem on the surface, many find to their dismay that such processes are not.

Giving Abatec’s buyers, Richard Buchanan and Robert Dyer, as an example, Denniss explains: “The people who are involved are not familiar with doing it. It’s not something that they’ve got experience of doing; they’ve never done it before. They only do it once in a lifetime or generally that level of frequency. So, there isn’t any learning curve,” he says.

And buying a business that you’ve worked for is different still than buying a company you’re less familiar with. “I think the biggest difference is that within MBO, there is an element of believing that the people who are buying it would get a slight discount because they have been involved in actually building the business up to where it is,” Denniss says. “And then that is reflected in the price.”

As far as the vendor is involved in an MBO, “the warranties and indemnities which the vendor has to give… tend to be less where you’ve got an existing management team who are continuing because they know what’s in there, they know the warts and all, and therefore that makes it easier to actually agree those aspects, which can be quite time-consuming and onerous.

“Someone buying it fresh has got no idea whether there are any skeletons in the cupboard. In actual fact, they’re not even sure where the cupboards are,” Denniss says.

Another contributor to greater transparency in an MBO is the fact that the continuing management team has been “incentivised to make it work. There is a better chance of being successful”, Denniss says.

A few ‘need to knows’ when embarking on an MBO: be aware of tax risks in how the deal is structured. “If you’ve been employed by the business before, how would you structure this so that HMRC [HM Revenue & Customs] do not want a big bite of the cherry?” Denniss asks.

Typically, an MBO deal is structured by putting a new holding company above the existing company. “That’s the absolutely standard model,” Denniss says, “because that then gives the flexibility as to how you buy out the person who is selling it. Typically, you don’t give them all the cash on Day 1. Some of it is left behind as a vendor loan, and then that is set up through the holding company. The new holding company doesn’t do very much other than agree to buy out the exiting shareholder for a sum of money, plus some IOUs.”

Negotiating the terms of the IOUs requires careful thought of such questions as, “What are the terms of the IOU? Does it carry interest? How quickly is it going to be repaid? Is the repayment linked in any shape or form to the profitability of the company?”

In his work with MBOs, Denniss says he has put in “various particular strategies” that might reduce the risk of the deal going sour: “I’ve seen a lot of these where the obligation to pay the vendor is too high, if there is any wobble in the market.”

He adds that everything may seem to go “nice and smoothly without a problem, but you only have to have one month that doesn’t go nice and smoothly, and all of a sudden, the purchasers are left very exposed.”

Often, Denniss says, MBOs are conducted “amicably… until they go wrong. They can get fraught particularly when circumstances change unexpectedly. You’ve not got a deal until the deal is signed”.

What happens, he asks, if “something fundamental” changes the day after the deal has been inked? It might be losing the company’s major client, or a key individual falling ill, or perhaps a pandemic. “Suddenly we find that the income streams that everybody is set to be predicting are no longer there – has one party lost out significantly? Should more protections have been put in for that party?” he says.

Denniss recommends that both parties contemplating an MBO retain “a good accountant”, preferably chartered, to work out what the contract will look like in terms of commercial considerations. In terms of personal and professional characteristics, Denniss suggests that the accountant should be able to both examine and analyse history in the accounts and to look forward. “You need to budget for professional time and cost,” he says.

Image credit | Tim Martin

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