A management buy-out (MBO) is an attractive option for a business owner looking to exit. In an MBO, an internal team takes over the venture from an existing owner, which might be from a parent company.
If you are looking to embark on an MBO opportunity as a buyer, one of the primary challenges you will have to overcome is funding the process. Acquiring a business and its assets can require significant external funds, especially if the existing owners have high expectations.
Fortunately, there is a mixture of equity and debt options on the market that can support you and enable you to complete the MBO process.
Below, we’ve listed the best options for MBO funding.
Management investment
In most management buy-out scenarios, much of the funding will come from external sources. In numerous cases, the incoming management team will need to put their own money down to secure the purchase, such as if there is a gap in external finance or it is a requirement of the funder.
This money might need to come from savings or even a re-mortgage of your property. It indicates the team is committed to the process and willing to put themselves at personal risk – meaning they are more invested in its success. This can convince the funder and the seller that they have chosen the right owners to take over.
Commercial finance
When seeking external finance, there are two main sources – debt or equity. Within the debt field, there are a range of potential solutions to fund the acquisition from commercial loans and invoice finance to stock finance and asset finance.
There are many commercial solutions on the market, with a mixture of banks and alternative lenders providing choice. The key is finding a way to package the different elements together to provide as much as the funding you require as possible, which will be dictated by the criteria of the lender and your eligibility (usually tied to the risk factor you present).
If you have security in the form of assets, this can help you to secure more risk averse lenders. As the borrower, you can pledge business assets (equipment or property) of the target company or personal assets. This reduces the risk faced by the lender, which means they may offer you a lower interest rate and other fees.
It is likely you may also be required to sign a personal guarantee. In this case, it’s wise to protect yourself with personal guarantee insurance.
You will be required to present robust financial management projections, including cashflow forecasts that model the proposed debt that the business intends to take on, to support your funding applications.
Equity
The alternative to debt funding is equity investment. With this route, you receive finance from interested investors in exchange for equity in the company, which entitles them to a share of your dividends and return on their investment in the long term.
MBOs tend to be attractive to investors as they can lead to high growth or significant business turnaround that increases the value and generates a substantial return on investment.
As with all types of finance, you will need to invest the time in finding suitable investors to work with you and effectively convince them that you have a solid vision for the company and the ability to lead. Usually, this requires an effective plan and pitch that highlights growth potential.
Many entrepreneurs fail the first few times they seek investment, making it a long, tiring process. However, those who succeed can generally raise vast sums of money and additionally benefit from practical advice from experienced investors.
You will also want to consider the timeframe of the investment. Depending on the type of investor you work with, their intended exit can vary. If they wish to exit after a few years, you need to ensure you can drive success that delivers their desired ROI in this time. If it’s longer, you need to commit to an extended relationship, during which the investor has an influence over company decisions.
Mezzanine finance
If you cannot address your needs exclusively through either debt or equity, consider combining the two with mezzanine finance. By incorporating both, you can bridge potential gaps in your funding and pool together your funding streams to cover the buy-out. It’s also a flexible form of finance, so various needs can be met.
If you are looking into a mezzanine solution, it’s vital to find an option that works for you. Mezzanine lenders tend to have set criteria you need to abide by, and it can be more expensive than other forms of finance (though this may have less impact in a high-value buy-out).
If you are mixing debt and equity, you also need to understand the knock-on effect to your company. In some cases, a lender may insist on restrictive covenants you need to stick to during the loan or investment period. You need to make sure there are no conflicts of interest.
Seller financing
Another funding source when raising money for an MBO is seller or vendor financing. This is when the seller agrees to facilitate the buy-out by deferring a proportion of the purchased price to a later date. This is might be done via loan notes, which the buyer then pays back over an agreed period.
There are several reasons a seller may choose to do this. Firstly, if they want a specific team to take over the company, this helps them do so without the pressure of overburdening the business with external finance, thereby enabling the company to carry on with the desired leadership.
Secondly, it can be helpful in situations where the purchase price cannot be achieved, the seller ‘earns’ part of the price by showing there can effectively improve post-purchase performance. If the buyer achieves these results, the seller is compensated. This is known as an earn-out. This method is also used where there is a deferred consideration as part of the purchase, although such deferred consideration isn’t linked to future results.
It benefits the buying team, as it reduces the amount of capital they need to raise immediately. If a seller has agreed to finance the transition, it highlights that they have confidence in that team to successfully take over the company and repay them. This can improve the attractiveness of the MBO to other funders, making it easier for the new team to raise finance.
Conclusion
MBOs tend to be high-value propositions. Raising the capital to cover one can therefore be a big ask, so understanding the most common options for financing is crucial to success.
By finding options that suits your needs – whether it is debt, equity or a mixture of sources – you can secure the funding you need for a successful buy-out that benefits both the seller and buyer.
From there, you can focus on achieving the best possible performance from the company and showcase your strong leadership.
If you want to finance a management buy-out, we can take you through the best solutions for your needs and eligibility.
Get in touch with us today to discuss the best options for you.