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How to Finance a Management Buyout

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A Management Buy-Out (“MBO”) does what it says on the tin – this is where managers of a company purchase the share of a business from the current owners.  There has been a steady rise in MBO activity and transactions over the past few years as managers look to realise their ownership ambitions.

When managers want to take over a company, they may know their business inside out but could be put off by a lack of knowledge around financing the proposition.  The funding landscape and appetite for MBO activity has broadened considerably over recent years which mirrors the increase in transaction activity.  Funders pay particular scrutiny and attention to MBO transactions as they are not making an investment in the business but in the management team buying it.

Getting your funding options and decision right are key and presenting information to get the right interest and offers in place is an absolute must.  There are some component parts which drive the deal structure from a financial aspect and we consider these here.

Management Equity

It is important that the buyers contribute their own cash or assets towards the buyout. Funders will want to see what some term as “Pain Money” contributed to the deal.  The personal investment demonstrates the commitment and belief from management to other externalities. The amount of equity does not have to be vast, however typically represents 6-12 months’ salary.

Financing the deal

Although acceptance for this may be tricky, funding from banks can be effective and cheaper than other methods. The loan will be paid fixed term with fixed repayments which makes it very inflexible. The lender will take many factors into consideration before acceptance. These include; personal credit, net worth, current and future prospects.  Mainstream lenders are pretty rigid on security being in place too but schemes such as the Enterprise Finance Guarantee should be explored where there is insufficient security available.

Alternative lenders are very much in the MBO space and whilst may be pricier than a security backed, mainstream deal – they will look at forecast led lends which is an investment in the future of the business and confidence in its ability to hit the forecast and business plan numbers.

Use of invoice finance to leverage debt from the target business’s balance sheet should also be considered.  This can work very effectively in a deal structure alongside an element of loan, term debt.

Private Equity

The management team may be able to secure financing through a private equity firm. The acquisition might have to be quite large to be of interest to the PE house though. Their investment may consist of share buying, loans and asset-based financing. PE firms will often want to exit after 3 to 6 years and you should be ready to work to their timeframes.  There is however increased appetite and interest from the private equity sector in MBO transactions with a number of specific funds in place exclusively for that purpose.

Seller Financing

On some occasions, financial endorsement of the management team by the vendor is beneficial. Seller loan notes can soften the blow of the initial consideration by reducing that completion pay-out.  This can also provide some comfort to the funder as not only does it reduce risk related to the amount of funding required but it also shows confidence from the seller – confidence that the buyers will make a success of the business and be able to pay the loan notes at the relevant future point.

What do you need?

Overall, funding would require a credible plan from the management team, suitable levels of personal financial commitment and an introduction of external investors. The correct selection and presentation of these should be carefully thought through to avoid an unsuccessful buyout outcome.

Verde has considerable MBO experience and provides a comprehensive advisory piece hand holding the management team from start to finish.  Our approach is to entirely look after the financial requirements of the deal – preparing and presenting information, selecting and negotiating with funders and onto deal completion.  One such MBO transaction that Verde has assisted on was for Paramount Office Interiors. We created a suitable funding package which leveraged debt and reduced risk for the management team. The management buy-out process was completed to deadline with a flexible funding structure that suited buyer and seller. Paramount say “Verde Corporate Finance removed all concerns around the MBO process. Everything was managed efficiently with clear communication of progress throughout the project… We would thoroughly recommend the Verde team”.

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