The usual format that is adopted in structuring a Management Buy-Out (“MBO”) is that a new company is formed (commonly known as “Newco”) to purchase the shares of the “Target Company”. On completion, the equity investors and the managers become shareholders. At the same time, some of the managers will also become directors and in all probability will be joined on the Board by a representative of the equity investors, as a non-executive director.
Newco will, after receiving the necessary cash injection, proceed to purchase the shares of the Target Company.
Managers may well be employed by and/or be directors of the Target Company, and as such, they will bound by the terms of their service contracts as well as, in the case of a director, owing significant fiduciary duties. Investors backing the transaction will need to see confidential information and managers would be well advised to obtain the prior consent of the seller to avoid the risk of being dismissed for breach of contract. This will generally be dealt with by way of a confidentiality agreement between all the parties involved.
There will be a number of legal documents depending on the complexity of the deal and the financial structure. In addition to the main contract Share Purchase Agreement, there will often be facility letters, loan agreements, personal guarantees and security documents emanating from any banks involved; director’s employment contracts for the managers, and probably a subscription and shareholders’ agreement with equity investors and the managers.
A subscription and shareholders’ agreement will cover such matters as:
- the composition of the Board;
- undertakings as to future funding; and
- provisions for realising the investment and veto over certain events such as acquisitions or sales of subsidiaries or assets.
Certain key provisions would be included in new Articles of Association which would also cover:
- the rights of the various classes of shares;
- dividend rights;
- issues of new shares;
- transfers of shares;
- provisions for Board and General Meetings; and
- powers and duties of directors.
The terms of any banking documents involved will be based on the bank’s standard terms and it is unlikely that anything other than the key commercial terms will be the subject of negotiation.
In addition to the (probably limited) set of warranties that Newco will look to take from the seller, one of the most important aspects amongst the mass of documentation that will confront the managers is the warranties they will be required to give. Any investor providing the finance involved in a management buy-out is going to be looking to the managers to provide certain comforts.
Generally, managers will be required to give the warranties and they will, no doubt, argue that they are risking potential bankruptcy despite the fact that their contribution to the overall investment may be relatively small. From the institution’s point of view, however, the warranty process serves to focus the minds of the managers on the issues in hand, although one of the key tasks of the managers’ solicitors will be to negotiate suitable limitations on the warranties.
The managers’ solicitors will also need to be involved if warranty insurance cover is taken out by the managers.
5. Due Diligence
The legal due diligence procedure is monotonous and time consuming, but nevertheless vital. The depth to which each area needs to be covered will depend on the nature of the Target Company’s business, but generally will include such matters as the ownership of shares and assets, material contracts, litigation, taxation, environmental aspects and regulatory requirements. Although vigilance is important in this verification process, the ability of the managers’ professional advisers to concentrate on the relevant issues rather than wasting time (and consequently legal costs) on the worthless minutiae is to be valued.
6. Restrictive covenants
The legal position relating to restrictive covenants is uncertain, with the Courts unwilling to enforce covenants that they believe go beyond what is reasonable to protect the goodwill of the business. Nevertheless, any investor, which includes the managers themselves, who has injected substantial amounts of money into the Newco, will not want any of the managers involved to leave Newco after a relatively short period and go into competition elsewhere.
Non-solicitation of employees and/or clients can often be of prime importance as well.
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