Funding options for management buy-outs

Management buy-outs (MBOs) are a popular exit route for the owners of companies, whereby the senior management team purchases the assets and operations of the business. The management team is able to lead the business and implement new strategies and directions as it sees fit.

How does a management buyout work?

Each MBO is different, depending on the circumstances of the business being bought. However, an MBO will typically involve the following steps:

• Spotting the opportunity
• Valuing the company
• Negotiating deal structure
• Performing due diligence
• Sourcing funding
• Exchange and completion

Once the deal structure has been finalised, this will determine the amount of funding required. Any analysis of debt required to complete an MBO should take into consideration the affordability of repayments of both debt and any deferred consideration, as well as the ongoing working capital requirements of the business.

When it comes to sourcing funding to facilitate the MBO, this can come from a variety of sources. Each has its own advantages and disadvantages, and these will vary depending on the circumstances of the business and the individuals within the management team.

Deferred consideration

Deferred consideration is finance provided by the company owner(s), allowing the MBO team to repay an amount, at agreed intervals, following the sale of the business. There is no limit as to the amount that can be deferred, although vendors will usually want to receive as much upfront consideration as possible.

Deferred consideration can be conditional on a number of factors including the future financial performance of the business which can protect the MBO team should the performance of the business decline post-transaction.

MBO team cash injection

It is rare that the MBO team will be able to fund the full amount to purchase the business using their own personal resources, due to the high level of cash they would need to have available.

More often, MBO teams will inject an available level of cash alongside obtaining debt from lenders in order to facilitate the transaction, and in some cases, lenders can insist upon the MBO team injecting cash in order to share some risk in the transaction.

Term loans

Term loans are available, typically over a maximum period of five years, in order to facilitate an MBO. Lenders will assess the affordability of any borrowing on both the past and future financial performance of the business.

Invoice finance

Invoice finance works by using a company's unpaid invoices as security for a loan. A lender will advance up to 90% of the value of the invoices and when due the customers pay the full balance into a trust account held with the lender.

This type of borrowing is typically used for working capital, however, if the business sells products on credit terms to other businesses, this is often used to provide funding to support MBOs.

There are no monthly amortisation payments, which eases pressure on cashflow and can allow the business to utilise free cash to repay any deferred consideration or invest into the business.

Asset-based finance

Asset-based finance is similar to invoice finance, but can release cash against further assets held on the balance sheet of the target business, including plant and machinery, property and stock.

It can be advantageous to the cash flow of the business and allows the MBO team to leverage the assets held within the company. Asset-based lending can be a combination of working capital-style facilities as well as term loans, which is dependent on the type of asset being leveraged.

Each of the debt options discussed above can require borrowers to provide security to the lenders in order to obtain the required borrowing. This security can be sat within the business being acquired or can be provided by the individuals involved in the MBO team, or both. 

Expectations of MBO team

In most circumstances, the maximum leverage provided by lenders will be less than the total purchase price, so any shortfall will need to be met through either MBO team contribution, deferred consideration or a combination of both.

Each of the debt options discussed above can require borrowers to provide security to the lenders in order to obtain the required borrowing. This security can be sat within the business being acquired or can be provided by the individuals involved in the MBO team, or both. In almost all cases, a lender will expect the MBO team to be taking a level of personal risk that is meaningful to them.

Private Equity

If the MBO team is unable or unwilling to borrow the funds to purchase the business, it can approach external backers, who will provide capital to finance an MBO in return for equity in the target business. This capital is usually raised from Private Equity firms, who will take a shareholding in the business, a seat on the board and can take dividends.

What is the best way to fund an MBO? 

There is no right or wrong way to finance an MBO transaction, this is entirely dependent on the circumstances of each of the parties involved and the expectations and wishes of both the exiting owners and the incoming MBO team.