Vendor Inspired Management Buyout
A Vendor-Inspired Management Buyout (VIMBO) is suitable for privately owned / managed companies where succession / exit / value realisation are issues. Good quality second-tier management is important and available cash / debt capacity are helpful, but not essential.
The vendors effectively set the price, usually at the top end of expectations.
Financing is through a combination of cash (if any) or equivalent in the balance sheet and debt capacity (to an sensible degree) which are used to fund an upfront completion payment with the balance of the consideration paid on a deferred basis (often through loan notes) over a period of time.
A new company (Newco) is formed to acquire the shares. The vendors may or may not retain a minority shareholding, with the management team holding the balance (in pre-agreed percentages). The level of share capital required in Newco (and the ‘buyin price’ for the management) will be influenced by whether there is a requirement for bank debt.
The vendors’ loan note / share interests are protected by means of a loan note rights / shareholders agreement (including the right of the vendors to resume control in the event of any default by the management team). This may be an issue for negotiations depending on the buyin price for management. The lower the buyin price, the less the risk, the less they should be concerned in terms of financial exposure.
Benefits for Vendors
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The vendors can secure a premium price as they control the transaction and set the price and timing of payment;
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Tax efficiency is built in, principally by virtue of deferral of CGT for the vendors until such time as they receive cash;
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The vendors give minimal warranties to the purchasers as the management are expected to know the business well (this may vary if there is an external buyin candidate on the team);
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The vendors can also continue to exercise a degree of control through a loan note rights / shareholders agreement in order to ‘protect’ their investment (i.e. the loan notes). If the financing structure permits, the loan notes can be secured;
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This structure addresses issues of succession and control during the wind-out / exit period as these are largely fixed through the operation of the documentation;
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The vendors may elect to retain a stake in the Newco, so that they have a carried interest with the potential for a further gain if the business prospers. Whether this is appropriate depends on negotiation with the management team; and
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If the structure if properly set up, the management team should be incentivised to perform over the payment period (and therefore potentially do a similar deal themselves in future).
Benefits for Management Team
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The cost of entry can be low – the only personal cost is the agreed investment in Newco and, for the right target, this could be a nominal sum;
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The risk is also low in that management are investing in a business they know well (unless of course there is an external buyin team member);
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They will ultimately own the business and so be able to do a similar deal in future (or simply sell in the ‘usual’ way);
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There is the potential for a significant capital gain to accrue for them as the debt to the vendors (and any external component) is paid off; and
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The vendors are likely to be more sympathetic lenders / investors than a bank / private equity provider (particularly in the current market).
Tax treatment
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Cash consideration will be subject to CGT at 18% (10% on the first £2m of gains for each vendor);
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Newco Shares – there is no CGT in respect of the value received by way of an ongoing shareholding in Newco until such time as those shares are sold, at which time CGT will be chargeable at the rates (and subject to the regime) applicable at that time on the gain (if any) arising (based on a base cost equal to the market value of the shares sold at the time of the VIMBO); and
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Newco Loan Notes – the exact tax treatment will depend on circumstances, but it can be structured favourably (and the loan notes secured – the manner depending on the overall financing structure).
Entrepreneurs’ Relief – Important Note
It’s important to note that for the 10% rate to apply to the first £2m of gains, the target company must be a trading company.
HMRC’s interpretation is that if the balance sheet of the target shows substantial (which HMRC take to mean 20%) assets which are not used for the trade, they may take the view that the target is not a trading company and deny Entrepreneurs’ Relief. Other factors have to be considered as well, so it is not always easy to come to a conclusion on this. While it is possible to apply to HMRC for a ruling on this before entering into a transaction, the matter should be fully considered before taking such a step.
On the assumption that full Entrepreneurs’ Relief is available to each vendor, the potential cost to each is £160,000 (8% of £2m).
As part of the deal planning process – and certainly before any approach is made to HMRC for a ruling – there are strategies that can be considered that might assist in mitigating this potential cost (recognising of course that any such strategy must be cost-effective bearing in mind the likely cost of implementation). This structure will not work for all businesses – but in the right circumstances, it can offer an alternative route to sell a company where the market is crowded and valuations are also affected by the lack of available credit to buyers.
FOR FURTHER INFORMATION PLEASE CONTACT: BILL FOWLER
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