MBO Financing Structure: Should You Defer?

Considering a management buy-out or buy-in (MBO & MBI)? The deferred management buyout option might be worth considering – but you’ll need specific support from financial lenders to make it happen

Most MBO teams need lender support to acquire shares. Though some deals involve raising a cash value and buying out a director with an upfront payment, alternative structures exist, such as the deferred management buyout and private equity investment.  

In a deferred buyout, the buyers become directors and shareholders of a new company. Using this company, which the seller has no part in, they will then acquire the existing business. The seller then acquires the cash in the business minus any pre-agreed working capital reserves. The remaining balance is then spread out via loan notes to be paid to the seller over an agreed-upon period. 

To facilitate the purchase and the subsequent loan notes, you’ll likely need the support of a lender. Rangewell can help you raise finance with lenders who understand the MBO and MBI process, meaning you can negotiate a more suitable deal that meets the needs of both parties. 

Understanding deferred management buyouts (MBO)

For most buyers, paying the seller the full asking price is impractical or impossible. Lenders may not even offer you the loan you need if you indicate you want to pay upfront, as it exposes you to more risk than spreading the cost through deferred consideration. 

Deferred consideration allows the buyers to defer payments, either to a fixed value or against the expected performance of the business (sometimes called an ‘earn-out’). In some cases, this will be calculated against the company's projected EBITDA over a set period of time. 

In an MBO, a deferred management buyout takes a specific process where the buyers form a new company to become directors and stakeholders. This company then acquires the seller’s business, which means the seller gains access to all of the cash in the original business. 

In most cases, the value of the business far outweighs the cash within it, so the outstanding balance needs to be dealt with. The balance will be deferred through loan notes, which are issued at set periods in a repayment timeline (usually a number of years). The seller will receive income from these loan notes and will remain a minority shareholder until the balance is cleared. 

Deferred MBOs for sellers

As a vendor selling your business, you want to receive the maximum possible reward for your hard work. However, it’s often impractical to expect buyers to raise enough cash to pay your asking price outright. 

Here are the main considerations you’ll need to bear in mind when making a decision:

• Provides a steady income stream over the agreed period, which may be useful for long-term stability but is less appealing if the seller is elderly and wants as much up-front value as possible. 
• Deferred payments may also incur less tax liability than a single large up-front payment, depending on how it is structured. 
• A deferred MBO usually means you’ll be paid more over the longer timeframe than you could ask for up-front, with some deferred MBOs offering 20-30% greater return than an upfront sale. 
• You’ll remain a minor shareholder in the business and will therefore have some say over future proceedings. It helps demonstrate a long-term commitment to the business’ success and may help improve lender confidence as it shares the risk.

Deferred MBOs for buyers 

As a buyer, a deferred payment system is often not just a desire but a necessity. Lenders may decline to issue finance for up-front buyouts unless the buyers have a way to mitigate risk or offer assets as security. A deferred system is preferred because it spreads the risk and repayments over a longer timeframe. 

As a buyer, you should consider the following:

• Deferred buyouts mean you won’t need to deplete your resources immediately to fund the purchase and will therefore have better access to cash flow. 
• Your repayment burden should be spread out across a set timeframe, which allows you to use the business to generate profit that are then used to repay debts. 
• The seller will remain a minority shareholder, which can be a good thing as it means they’ll have a vested interest in future success and helps keep them aligned with the business’s financial performance. However, it does mean the buyers won’t have full independent control. 
• If the deal is structured around earn-outs, or performance clauses, you’ll need to ensure both parties are happy with how the deal is structured AND make sure lenders are happy with the plan. 

Financing a deferred MBO

As with any type of loan, a lender looks to base their decision on the perceived risk of the deal. A deferred management buyout means they’ll want to see a strong business plan from the buying team and an accurate valuation. 

The complexity of these transactions means you’ll need to find a lender that understands the MBO process and can support a deferred payment plan. Rangewell can help you find the right lender and negotiate a deal around either a fixed value, or a projected value based on the EBIDTA of the business. 

If you’re considering an MBO, speak to Rangewell to see how we can help you finance it most effectively to satisfy both parties and lead to long-term financial success.