Management Buyout Financing Explained

A management buyout (MBO) is a strategic financial decision that occurs when a company’s management team acquires the assets and dealings of the company they manage. In this guide, we will go over how you can secure funding and what support we can offer you.

What is an MBO and how do they work?

An MBO transaction involves an incumbent management team (Buyers) acquiring a controlling stake in their company from its owners (Vendors). This allows the Buyers to continue to operate the company for the foreseeable future.

This ideally gives the Buyers full autonomy over the business, while the Vendor receives fair consideration for their shareholding and can agree to a harmonious exit. It should be a win-win for both sides.

However, before the ownership changes hands, both parties will need to address each other’s objectives and concerns. Transactions of this kind depend on both parties being able to compromise and gain assurance around key factors.

• Buyer’s ability to raise the necessary finance.
• Buyer’s level of comfort with the business’s performance and forecasts to ensure a return on investment.
• Vendors may be concerned about the future of the business and would want to understand the Buyer’s long-term business plan.
• Vendors will likely wish to maximise the consideration as shares received while Buyers will have the opposite objective.
• Assuming agreements are reached during negotiations, the next key question is: “How can management raise MBO finance to complete the purchase?”

Assuming agreements are reached during negotiations, the next key question will be: “How can management raise MBO finance to complete the purchase?” Further down the page we go into the different methods Buyers can use to finance an MBO.

Sources of finance for Management Buyout

There are a number of strategies Buyers can use to finance an MBO. A Buyers’ choice will come down to their business objectives, risk tolerance, debt assessment and the level of control vs equity they want to maintain when taking over the business.

Management equity – Buyer uses their own finances

The simplest way of raising funds for a management buyout is for the Buyer to use their own finances to do so. But the Vendors may ask for more than Buyers have available for purchasing.

As a result, the lending market has recognised the importance of third-party funding for achieving buyouts. Banks and private equity funds (PE) have satisfied this requirement by providing lending facilities in the form of debt or in return for equity in the target business.

Buyers will have to invest a substantial amount of management equity in any MBO relative to their own finances, even when primarily funded by other parties. This is to give Lenders (banks and private equity) and Vendors peace of mind, seeing as the Buyer has committed their own personal finances to the business’ success.Generally, the more a Buyer commits to a buyout using their own finances, the more control they will be able to maintain once in charge of the business. Our expert team can assess your financial situation and help you draw up a buyout plan to achieve success in your MBO.

Debt financing – Borrowing against future business success

One of the most common means of raising capital to support an MBO comes in the form of term loans from third parties (typically referred to as Leveraged Buyouts). These loans can be borrowed against the future performance of the assets of the business and will typically be issued over a fixed term with fixed repayments that the business is liable to pay.

During the transaction, a range of institutions (Lenders) will be approached for funding. When determining if a loan facility can be granted, lenders will consider the historic performance of the business, assess the feasibility of the P&L and cash flow projections and review the asset value of the company.

For businesses which have historically demonstrated consistent earnings before interest, tax, depreciation and amortisation (EBITDA) and strong cash flows, an unsecured or secured term loan may be available. Unsecured loans carry the highest risks for the lenders and are less common than secured loans but obtaining either requires careful planning and presentation of the company’s financial data.

If a lender considers the EBITDA and/or cash flow to be outside of their risk profile, then they may consider an asset-based lending approach instead. Asset-based lending is a loan facility that is secured against the assets of the business. This is a riskier approach for Buyers, but the lower risk for lenders will make them more likely to accept it.

Deferred consideration and earnouts – what’s the difference?

Deferred consideration and earnouts are simply asking the vendor to delay receiving some of the money they are owed from the MBO to a pre-determined date in the future.

The key difference between the two options is that an earnout is tied to the performance of the business following the transaction while deferred consideration is a known fixed amount.

The rationale behind deferring the consideration is to allow time for the business (under new management) to generate additional cash which can then be used to settle the deferment rather than taking on higher levels of debt or sharing equity with a third party.

This arrangement increases the risk for the vendor and will need to be negotiated carefully. Our team can offer you expert advice, act as a buffer between you and the vendor, and advocate for your business goals. Get in touch here if you need any help.

Vendor financing – using share consideration as debt

Vendor financing is best described as a halfway house between deferred consideration and debt financing. In some instances, a vendor may be willing to forego a large upfront payment and instead opt to take a nominal amount of consideration initially. 

The remainder of the consideration will be financed through a loan note from the business to the vendor. This loan, similar to debt financing, will be repaid to the vendor over the life of the loan.

If you need help negotiating financing with your vendor, our expert advisers will be with you every step of the way.

Private Equity investment – debt financing using equity stake

Private equity (PE) firms frequently provide MBO finance through a blend of debt and equity, a structure often called a Private Equity Management Buyout. This will involve getting in touch with a Private Equity Manager who will help you with the buyout of the vendor’s business.

PEs will perform similar assessments to a debt lender. However, they will often request an equity stake alongside the buyers in addition to requiring interest on their loaned amount.

• The repayments made are less than debt financing as the debt portion is less than full debt financing and allows more free cash for investment.
• PE funds bring knowledge and contacts which can support business growth.
• PE funds may be willing to allow a further MBO on their shareholding providing buyers with the opportunity to acquire 100% ownership when the business is in a stronger position.

There is a lot to consider before going into Private Equity investment. But your expert advisers are here to help you.

If you are management team considering an MBO or a business owner looking to sell a business please do not hesitate to contact Philip Olagunju (philip@pemcf.com) who will be happy to support you.

Or, if you’d prefer, you can call us on 01223 728222 or contact us on our website here. Our experts will happily help you through the MBO process.