What are the benefits and challenges of a Management Buyout?
The upcoming Budget could see a rise in Capital Gains tax (CGT) rates so that they align with Income Tax rates.
This rumour has led to many business owners considering the sale of their business before they are subject to these higher rates.
For those considering an exit strategy, one option available is a Management Buyout (MBO).
This exit strategy involves a business’ existing management team acquiring the business from its current owners.
An MBO can be an appealing option for both the seller and the management team, as it offers continuity of business values.
However, MBOs come with unique benefits and challenges that both parties need to consider, including tax implications.
Benefits of an MBO
With the management team taking over, there is a smooth transition of ownership, which ensures minimal disruption to the business’ operations, employees, and customers.
For example, a manufacturing business with specialised machinery and long-standing relationships with suppliers would benefit from the continuity provided by an MBO.
This is because the management already understands the specialised workings of the machinery and can continue the supplier relationships, maintaining business momentum.
In addition, the management team is already familiar with the company’s inner workings, market conditions, and challenges.
This familiarity reduces risks compared to a third-party acquisition.
For instance, a retail business that relies heavily on seasonal trends can better manage stock levels and supplier relationships if the team that has historically managed these operations remains in charge.
When the management team becomes the owner, they are directly invested in the success of the business.
This can lead to more motivated leadership, as the team’s personal and financial success is now tied to the growth and profitability of the company.
Challenges to consider
An MBO is often financed through a mix of debt and equity.
The management team typically secures bank loans backed by company assets or personal guarantees, sometimes supplemented by private equity.
This can increase financial risk if the business experiences cash flow issues.
For example, if a logistics company undergoing an MBO is suddenly hit by a rise in fuel costs, the additional debt could threaten its financial stability.
The sale of a business to the management team will likely be subject to Capital Gains Tax (CGT).
Business Asset Disposal Relief (BADR) can reduce the CGT rate to 10 per cent on qualifying gains, up to a lifetime limit of £1 million.
However, if the Budget sees CGT rates align with Income Tax rates as speculated, a higher-rate taxpayer might see the CGT rate increase from 20 per cent to as much as 40 per cent, effectively doubling their tax liability.
The Budget could also see the removal of BADR, which would mean losing access to reduced CGT rates altogether, impacting the financial attractiveness of selling through an MBO.
The MBO process is demanding, and even once completed, the pressure continues.
Managing high levels of debt while leading the company requires a unified management team. Any cracks in the management team can become exposed under the stress of the transition, potentially threatening the stability of the business.
Is an MBO right for you?
An MBO can be an ideal exit strategy if the management team is capable, unified, and ready to take on the risks of ownership.
It provides continuity for the business and rewards the people who have been integral to its growth.
The potential changes in the upcoming Budget make it even more important to consider the timing and structure of your sale.
If CGT rates rise to align with Income Tax rates, or BADR is scrapped, the financial implications could be substantial, potentially reducing the attractiveness of selling now compared to later.
If you are a business owner considering an MBO or need advice on structuring the deal, speak with our team of experts today.
