What is a Vendor-Financed MBO?

Over recent months, our Corporate and Commercial team has been instructed on several Vendor-Financed Management Buyouts (MBOs). These are a popular choice for businesses across various industries.

In this blog, our corporate and commercial lawyers explain what Vendor-Financed MBOs are, how they work and how to finance them.

What is a Vendor-Financed MBO?

Vendor-Financed MBOs, also known as Vendor-Funded MBOs, are transactions whereby the people who run the day-to-day operations of a company, i.e. the management, acquire some or all the shares in the company.

The management team may or may not already have shares in the company before the buyout, although if they do, it will likely be a minority shareholding only.

How is a Vendor-Financed MBO financed?

MBOs can be funded by the buyer’s own existing wealth, or they can involve an external lender or investor. A key aspect of a Vendor-Financed MBO, however, is that the selling shareholders receive the purchase price from the buying managers on a deferred basis; in other words, after the sale is completed and the ownership changes.

Vendor-Financed MBOs are often an attractive way for buyers to take ownership of the company they already manage, and they enable them to fund the purchase from the trading profits of the business.

How is the purchase price paid?

The deferred payment of the purchase price can take several forms. For example, our corporate lawyers have recently assisted with MBOs where the purchase price is payable:

• In annual instalments over 10 years.
• In monthly instalments over five years, with interest accruing on the outstanding balance.
• On sufficient notice being served on the buyer by the seller (e.g. two months’ notice).

With all the deals above, a lump sum was also paid on completion of the sale. This can often be done where there is excess cash in the business on completion, with that cash being used to pay the exiting shareholder.

What are the benefits of an MBO?

• Sellers don’t have to market their business to external buyers. This typically incurs cost and opens the possibility of competitors gaining commercially sensitive information about the business (through the due diligence process). It can also be important for exiting shareholders to know the business and its staff will be in safe hands with the existing management, with the culture and independence of the business maintained.
• Formal due diligence may not be needed. Depending on the level of oversight the buyers have had over the business pre-sale, and how long they have had it for, a formal due diligence process may be deemed unnecessary. This can lead to an accelerated timescale and obvious cost savings. However, buyers should always consider whether they should carry out any formal due diligence on the business before buying.
• Flexibility. A partial exit from the company whereby the sellers still retain some shares is possible with an MBO, and this was the case with one of the sales Barcan and Kirby assisted with recently. In such circumstances, it can be beneficial to put in place a Shareholders’ Agreement and bespoke articles of association to govern the relationship between the remaining and new owners going forward.

What are the cons of a Vendor-Financed MBO?

The main potential downside of a Vendor-Financed MBO, at least for sellers, is that they do not receive all the purchase price on completion of the sale.

There is also the risk of the buyer defaulting on the deferred payment(s), whether out of their own choice, or because they are unable to pay them (i.e. the business does not generate enough profit). Things can be put in place to mitigate this issue. For example, the seller could take a debenture over the assets of the business, and/or a charge over the company shares (which was a security mechanism used in one of the deals we assisted with). This would enable the buyer to take back ownership of the company and/or sell off the assets of the business if the buyer defaults. This is obviously still not an ideal outcome for the seller and highlights the main disadvantage of a Vendor-Financed MBO, compared with selling to a buyer that has all the funds to pay the purchase price in full on completion.

How can Barcan and Kirby help?

Our corporate lawyers are well placed to assist buyers and sellers alike in Vendor-Financed MBOs, and can work with a range of purchase price structures. We can also assist with any legal due diligence where this is considered desirable.

It’s also important to take financial and tax advice on potential structures at the outset, and your company’s Accountant would be a good first port of call for this. Our corporate and commercial lawyers will then work closely with your Accountants throughout the process.

For an initial chat with a member of our Corporate and Commercial team, call 0117 325 2929 or complete our online enquiry form.