For most business owners a sale to a third party at the time you want to sell and for the price you want is at best very uncertain.  At worst it can be a wholly unrealistic ambition.

Any sensible buyer of your company will be very cautious.  Their advisers will warn them of the risks of overpaying.  They may want to structure the deal as an earn–out, perhaps paying you only 50% of what you think your company is worth on day one.  If things do not work out, this may be all you get.

The economic cycle may also work against you, or perhaps new technology and competitors into your market, may affect your profitability.  The pain as this happens may be acute for you as owner.  If you leave things too long and suffer a health problem (or die in harness) then you leave the problem for your spouse or loved ones.

For business owners who want certainty, a vendor-funded management buy-out can be a great solution:  a sale when you want at the price you want to a buyer you trust.  You let your team buy your business out of its future cash flow and you pay tax at just 10% on what you are paid as it is paid to you.

Stranger danger is eliminated:  done correctly this is a sale to a management team that you have put together.  A competent team who know your business and the markets in which you operate and who will be executing a tried and tested formula and business format that you and they have devised together. Doubtless your winning operation will be the result of very careful trial and error over many years of patient endeavour.

So what are the risks of which you must be mindful before you give up control of your precious business? 

Leadership/Management Risk:  The biggest risk may be if your business does not have a leadership and management team with the right skill set and resilience.  With the advice of independent advisers you can analyse and assess the capability of your team.  They may be better than you think or give them credit for.  But beware looking at your team through rose tinted spectacles.  If they are not up to the challenge and do not have the emotional resilience to succeed in a tough, competitive world then you must look for a trade buyer.

Assuming your team pass muster, what are the other risk areas and how can these be addressed?

Limited Up Front Cash:  On a vendor-funded buy-out you can expect to be paid over a period of time (usually 4-6 years).  A plus is often that the cash reserves (the surplus cash you have built up that is not needed for working capital) is paid out to you at the point of sale.  You can draw out that cash and pay just 10% tax on it.

You could ask the team to put in a material cash sum so you get more upfront.  You may even think they should have some skin in the game:  but often this is unrealistic as your team may not have personal funds or the means to raise them.  In today’s world people are often mortgaged to the hilt.

You might perhaps be able to sell an asset:  perhaps a sale and lease back of your premises.

An alternative could be unlocking cash through a bank loan or other debt finance such as invoice discounting.  These options may be costly and will mean you lose full control through the security over the assets of the business the bank will demand.

With a typical V-F MBO you will be the secured lender as explained below.  Having first and second charges is unlikely to work.

Default by the Buyer:  Suppose your MBO team hit a tricky commercial patch.  A customer may default on a contract or a supplier may let them down and they stop paying your deferred consideration.  With a well structured V-F MBO you will have the security a bank would have.  This will include a debenture so if the worst comes to the worst you could appoint an administrator to sell the business and pay what you are owed.

You would be well advised too to take a charge over the management team’s shares.  They will have formed a Newco to buy your company.  A neat structure is a personal guarantee from each team member but limited to the value of their Newco shares.  You take an equitable charge over the shares.  This coupled with a blank stock transfer and the deposit of the share certificates means you can be back in control immediately on default. Taking control this way can avoid the damage an administration would cause to goodwill and reputation.

Personality Clashes within Buyer Team:  People may behave in unexpected ways when put under pressure (and as we know being an owner-manager can test the mettle!).  For this reason a balanced split of the Newco equity amongst the team will be a good idea.

You will be well advised to retain equity yourself (perhaps 20% or more) and so for many years you may hold the balance of power and effectively continue as the benign leader of the business you have created.  This may be very important to ensure the team operates effectively.

The V-F MBO can see you as business owner become an investor in a business in which you were previously trapped. It can lock in and empower your team to grow your business.

The art of leadership it is said is to get other people to do what you want because they want to do it. The V-F MBO may just be the best kept secret in the enlightened owner’s toolkit!

For further information, please do not hesitate to contact an Everyman Legal Solicitor on 01993 893620 or email everyman@everymanlegal.com