Management buyouts: how an MBO of a private company works

What a management buyout is

A management buyout, usually shortened to MBO, is the sale of a company to the people who already run it. The owner wants to retire or move on, and the senior team wants to keep the business out of the hands of a competitor or a stranger. The managers know the business better than any outside buyer would, and the owner knows the managers, which is why an MBO can move faster and with less disruption than an open market sale.

The difficulty is money. A management team rarely has the price in the bank, so almost every MBO is built around borrowing, deferred payment, or an outside investor. The funding is settled first and the structure of the deal follows it.

Most of what follows applies to a company registered anywhere in the United Kingdom, since the Companies Act 2006 is UK-wide, and the employment and contract points are described for England and Wales.

The newco structure

The managers do not usually buy the shares in their own names. They set up a new company, referred to throughout the deal as newco, and newco buys the shares in the operating company, referred to as the target. The managers own newco, and newco owns the target.

The reason is practical. Debt raised for the purchase sits in newco, so the lender's claim is against a holding company with the target's shares as its main asset. An investor coming in for a minority stake takes shares in newco. Loan notes issued to the seller are issued by newco. Everybody's position is recorded in one company's share register and one shareholders' agreement, and the target carries on trading beneath it with its contracts, employees, bank accounts and VAT registration untouched.

Where the money comes from

Four sources appear in most MBOs, usually in combination.

Vendor loan notes. The seller lends part of the price back. Newco issues loan notes to the seller, repayable over an agreed period with interest. The seller stops being a shareholder of the target and becomes a creditor of newco. The seller takes a real risk here, since repayment depends on the business performing under new ownership, and the terms of the notes, the security behind them and what happens if a payment is missed take up a large part of the negotiation.

Deferred consideration. Part of the price is paid later, either on fixed dates or on the business hitting targets, in which case it is an earn-out. The seller should expect to negotiate protections against the buyer running the business in a way that suppresses the earn-out. Our guide to selling your business covers the seller's side of that in more detail.

Bank debt. A lender advances money to newco, secured over the shares in the target and, after completion, over the target's assets. Lenders will want the managers to have put in money of their own, will want personal guarantees in many cases, and will impose financial covenants that the business has to meet each quarter.

Private equity. Where the price is beyond what debt and the seller will carry, an investor takes shares in newco. The investor will expect a shareholders' agreement giving it consent rights over major decisions, a seat on the board, and good and bad leaver provisions attaching to the managers' shares. It will also expect an exit within a defined period, which changes what the managers have bought.

The mix is a commercial question, and the accountants lead on it. What the legal work then has to do is make sure each layer's rights fit with the others, so that the seller's loan notes, the bank's security and the investor's consent rights do not contradict each other.

The share purchase agreement

The document that transfers the shares is the share purchase agreement, or SPA. In an MBO it is drafted on newco's behalf and negotiated with the seller, and it does the same jobs it does in any share sale: it fixes the price and how it is paid, sets out what happens between exchange and completion if there is a gap, contains the seller's warranties, and deals with tax through a separate tax covenant under which the seller agrees to pay for tax liabilities relating to the period before completion.

Two features distinguish an MBO SPA from an ordinary one. The buyer already knows the business, which affects the warranty negotiation described below. And the seller is often staying involved through loan notes or a consultancy, so the agreement has to be drafted for a relationship that continues after completion. Our guide to buying a business covers the SPA from the buyer's side generally.

Warranties and the disclosure letter

Warranties are statements by the seller that particular things about the company are true: the accounts show a true and fair view, there is no litigation, the employees are on the terms disclosed, the company owns its assets. If a warranty turns out to be untrue the buyer can claim damages, subject to the limits negotiated in the agreement.

The disclosure letter is where the seller sets out the places the warranties are untrue. A properly made disclosure removes the claim the buyer would otherwise have, so the seller's protection is in the quality of the disclosure, and the buyer's protection is in the width of the warranties.

In an MBO this negotiation has a twist. The managers have run the business for years and know more about its problems than the seller does. A seller will argue that the buyer cannot claim for something it already knew, and will usually ask for an express clause saying so, together with warranties from the managers to the seller that they have disclosed everything they know. The managers will resist giving warranties to the seller about a business they are paying for. The outcome is usually a narrower warranty package than a third party buyer would get, backed by a shorter disclosure exercise, and it is one of the reasons an MBO can be cheaper to document.

Where a funder is involved, the managers will give warranties to the funder as well, in the investment agreement, and those are warranties about the business they know. The limits on those warranties, in time and in amount, are worth as much attention as the price.

Financial assistance and section 678

Financial assistance is the target company using its own resources to help somebody buy its shares. Section 677 of the Companies Act 2006 defines it to include a gift, a guarantee, security, an indemnity, a release or waiver, a loan, and any other assistance that reduces the company's net assets to a material extent.

Section 678 makes it unlawful for a public company, or a subsidiary of a public company, to give financial assistance directly or indirectly for the purpose of acquiring its shares, before or at the same time as the acquisition. Section 678(3) extends this to assistance given afterwards to reduce or discharge a liability incurred for the purchase, if the company is a public company when the assistance is given. There are exceptions where the principal purpose is something other than the acquisition, or the assistance is an incidental part of a larger purpose, and in both cases it must be given in good faith in the interests of the company.

A private company that is not a subsidiary of a public company is outside section 678. That is what makes the usual MBO funding structure possible: after completion the target can guarantee newco's bank debt and give security over its assets, and the lender relies on it. The directors giving that guarantee still have to be satisfied that it is in the company's interests and that the company can meet its debts as they fall due, and they should record the decision in board minutes, since a guarantee given by an insolvent company can be challenged later by a liquidator.

Where the target is a public company, or sits beneath one, section 678 applies in full and the funding has to be structured without the target's help until it has been re-registered as a private company. That is a specialist exercise and it changes the timetable.

The management team's own employment

On a share sale the employer does not change. The target still employs everybody, on the same terms, the day after completion. The Transfer of Undertakings (Protection of Employment) Regulations 2006 apply where an undertaking is transferred to another person, and in a share sale nothing is transferred to anybody: the same company continues, with different shareholders. So TUPE does not apply, and there is no information and consultation exercise with employee representatives.

If the deal is structured as an asset purchase instead, with newco buying the business and assets out of the target, TUPE does apply, the employees transfer with their terms and continuity intact, and the information and consultation obligations have to be met before completion.

What changes for the managers themselves is their own contracts. A funder will insist on new service agreements with notice periods, restrictive covenants and garden leave provisions that match the investment agreement. The managers' shares in newco will be subject to good and bad leaver provisions, under which a manager who leaves in certain circumstances has to offer their shares back at a price that depends on why they went. Those provisions decide what a manager who is dismissed, or who falls ill, walks away with, and they deserve at least as much scrutiny as the price of the shares going in.

Conflicts of interest and separate advice

The managers are directors of the target while they negotiate to buy it, and that puts them in a conflict the Companies Act deals with directly.

Section 175 requires a director to avoid a situation in which they have, or can have, a direct or indirect interest that conflicts with the interests of the company. Section 177 requires a director to declare the nature and extent of any interest in a proposed transaction with the company before the company enters into it. In a private company the board can authorise a conflict under section 175 if the constitution allows it, and the interested directors cannot count towards the quorum or vote on the authorisation.

In practice the management team declares its interest to the board at the outset, the seller consents to the managers using company information and time for the buyout, and the terms of that consent are written down. Managers who negotiate in secret, or who use the company's confidential information to build their bid without authority, are exposed to a claim for breach of duty whatever the deal's outcome.

Separate advice follows from the same conflict. The seller and the managers have opposite interests on price, warranties and everything else, and one firm cannot act for both. The funder has its own solicitors. Where the company itself is giving a guarantee or entering into a new facility, it may need advice separate from the managers who by then own it. And where the managers are more than one person, they should think about whether their interests are the same as each other's, since a finance director putting in a small stake and a managing director putting in a large one can want different things from the shareholders' agreement.

How long it takes

An MBO runs through the same stages as any sale, and the stages that take longest are the ones outside the parties' control.

Heads of terms. The managers and the seller agree the price, the structure and how the price will be paid, in a document that is mostly non-binding. A funder's term sheet is agreed alongside it. Two or three weeks of real negotiation here saves months later.

Due diligence. Lighter than a third party sale on the legal and commercial side, because the buyers know the business. The funder's due diligence is the part that takes time, along with any bank valuation of assets over which security is to be taken.

Documents. The SPA, the disclosure letter, the tax covenant, the loan note instrument, the facility agreement and security documents, the investment agreement, newco's articles and shareholders' agreement, and the managers' service agreements. They are negotiated in parallel and they have to fit together.

Completion. Board meetings of newco and the target, stock transfer forms, resignations and appointments, the funds flowing in the right order, and the filings at Companies House afterwards.

From heads of terms to completion, an owner-managed MBO with bank funding and vendor loan notes commonly takes a few months. Private equity involvement, property, regulatory consents or a public company target each add to it. The single biggest cause of delay is a funding condition that was not identified at the start, so the first job in any MBO is to find out exactly what each lender and investor needs before it will release money.

Frequently asked questions

How is a management buyout funded?

Usually through a combination of the seller lending part of the price back through loan notes, part of the price being deferred or linked to future performance, bank debt raised by the new holding company and secured over the target's shares and assets, and, for larger deals, a private equity investor taking shares in the holding company. The managers put in money of their own, which lenders and investors will insist on. The accountants lead on the mix; the legal work makes each layer's rights fit with the others.

Why is a new company set up to buy the shares?

So that the debt, the seller's loan notes and any investor's shares all sit in one holding company above the operating business. Newco borrows, newco issues the loan notes, the investor takes shares in newco, and the managers own newco. The target company beneath it carries on trading with its contracts, employees and bank accounts unchanged. It keeps the funding structure separate from the business being bought and makes every party's position visible in a single shareholders' agreement.

Do the financial assistance rules stop the company guaranteeing the loan?

For most owner-managed companies, no. Section 678 of the Companies Act 2006 prohibits financial assistance for the acquisition of shares in a public company or a subsidiary of a public company. A private company outside that description can, after completion, guarantee newco's borrowing and give security over its assets. The directors still have to be satisfied that doing so is in the company's interests and that it can pay its debts as they fall due, and they should minute the decision.

Does TUPE apply to a management buyout?

Where the buyout is a share sale, no. TUPE applies where an undertaking is transferred to another person, and in a share sale the company that employs everybody stays the same, with new shareholders. If the deal is structured as newco buying the business and assets out of the existing company, TUPE does apply: the employees transfer with their terms and continuity, and the employer has to inform and consult representatives before completion.

Can the same solicitor act for the owner and the managers?

No. The seller and the management team have opposite interests on price, warranties, the terms of any loan notes and what happens if the business struggles afterwards. Each side needs its own solicitor, the funder will have its own, and the company may need separate advice where it is giving a guarantee. The managers also owe duties to the company under sections 175 and 177 of the Companies Act 2006 while they negotiate, and their interest should be declared to the board and authorised at the outset.

What are good leaver and bad leaver provisions?

Terms in the shareholders' agreement or articles that decide what happens to a manager's shares if they leave. A good leaver, typically somebody who dies, retires at an agreed age or is made redundant, is usually paid fair value. A bad leaver, typically somebody who resigns early or is dismissed for misconduct, may receive only what they paid or less. Investors insist on them, and the definitions are negotiable, so they are worth reading against the situations most likely to arise.

Sources & further reading

• Companies Act 2006, section 678: assistance for acquisition of shares in public company
• Companies Act 2006, section 677: meaning of financial assistance
• Companies Act 2006, section 175: duty to avoid conflicts of interest
• Companies Act 2006, section 177: duty to declare interest in proposed transaction
• TUPE Regulations 2006, regulation 3: a relevant transfer
• GOV.UK: business transfers, takeovers and TUPE

This article is general information, not legal advice. The law changes and depends on your circumstances — always take advice on your specific situation before acting. Last reviewed 22 September 2026. AD Solicitors Limited is a recognised body regulated by the SRA (no. 8011228).