MBO Finance: Finance for a Management Buyout
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Management buyout finance - MBO finance
Acquiring an existing business in a Management Buyout can be an excellent investment. The returns can be substantial - but the investment required will be high
Table of Contents
Management Buyouts allow a company’s management team to buy the assets and operations of the business they manage from the owners. This can be a single manager or a wider team pursuing a purchase that includes all assets and liabilities associated with the business. Like many other types of business transactions, you'll need significant capital to finalise an MBO -- which is why most people turn to lenders to raise MBO finance.
What is an MBO?
A management buyout, as we've explained above, is when a team or individual at the managerial level purchase the business they work for from the owners. In doing so, they take on all assets and liabilities and become majority shareholders.
To pursue an MBO, the buying team will need to approach the owners and outline their plans. This can be risky, so it's best to be as prepared as possible with a clear business plan and a case behind why your team wants the buyout to occur. To assuage potential owner frustration, try to outline the benefits for them too.
The reasons behind an MBO vary but generally boil down to a few common scenarios:
- The management team disagrees with the direction the owners are pursuing for the business.
- The existing owners are seeking to leave the business or retire.
- Managers want to reap a higher financial reward for their efforts and feel ownership is the only way to achieve their desired earnings.
- Managers lose confidence in the owner's expertise and feel they can drive better growth in the business.
MBOs must be well planned ahead of time as they require negotiations with the owners, finance lenders, wider team and employees. The advantages, of course, are that the mean acquiring a business that they know and understand - and the greater rewards that come from being the owners of the business rather than employees.
Advantages of a Management Buy Out
MBO's carry lots of advantages for the buyer, which include:
- Increased earning potential through share value and dividends
- Removing potentially stagnant ownership to revitalise growth
- Smooth transition for employees, clients, trading partners etc
- Protects sensitive and proprietory information by keeping it within the business
There are lots of advantages to the selling owners too:
- Reduces the complexity of the sales process
- Eliminates the need to list the business on an open market or approach competitors
- Grants reassurance that the business is being passed to experienced hands
A key benefit to an MBO compared to setting up a new venture is that the business already has a record of financial performance and hopefully, profitability. This avoids some of the costs and uncertainties of setting up a new business and can help reassure potential investors. In almost all cases, you'll need to source finance from lenders or investors to help purchase the share capital - unless you're willing to risk personal capital.
There are many ways to deal with the costs of an MBO. Once a price has been agreed - which may be at a substantial discount on the market value of the business - it usually requires a combination of debt and equity that is derived from the buyers, financiers and sometimes even the seller, and can be structured in a number of ways such as a conventional purchase or a leveraged buyout model.
What is the difference between a MBI and an MBO
There is sometimes confusion between the terms MBI and MBO. A management buy-in, or MBI, is when a team that is external to a business tries to buy the business. This may be a competitor or an entrepreneurial individual - but it is always someone who is not associated with the business or management in a direct capacity.
Unlike an MBO, where the internal management team is acquiring the business, an MBI means bringing new personalities and perspectives to the company. They tend to be more disruptive because in most cases, they will replace the existing management team as well as the original owners. In an MBO, the management team will generally remain in control or will promote new managers from existing staff.
What about Leveraged Buyouts and Earnouts?
A Leveraged Buyout, or LBO, is where a company is purchased with a combination of equity and debt. It means that the company's cash flow is used to secure and repay the borrowed money. They are often used because few management teams have the financial resources to buy the target company outright. They need external financing to facilitate the purchase and are often dependant on leveraging some of the assets of the target company.
An Earnout is an arrangement where the seller finances a portion of the purchase price. The repayment of this portion is achieved from a predetermined sum or proportion of future earnings.
Both Leveraged Buyouts and Earnouts require careful structuring to succeed - they will also require external funding.
How to finance an MBO
The first step to financing an MBO is to have a good business case in place to present to the owners and to form the basis of your finance application.
Existing owners may prefer a Management Buyout to a trade sale for a variety of reasons, especially if the owner feels that their company and its staff can best carry on in familiar, safe hands. If the owner was initially unsure about selling, a well-prepared business case from the management team can help demonstrate the value to the selling owner.
This initial business case should also form the basis of a new business plan, which you can use to approach lenders. Lenders are usually essential to your success because the majority of management teams don't have the capital required to purchase a business, or don't want to risk personal assets.
You should ideally have some insight into the lender's market before you consider approaching the owner. Without knowing your chances of securing finance, you risk causing friction or failing to progress the buyout. Rangewell can act as your financial expert, directing you to the right lenders who specialise in MBO and MBI transactions, working to assess and improve your business plan and negotiating on your behalf to secure finance at the most competitive rates and terms - all at no cost to you.
From a lender's perspective, MBOs have a few benefits: they are a safer investment as the business has demonstrable financial records and the new owners will know the company, reducing the risk of failure. An MBO reduces friction by ensuring that employees and trading partners can see the change as business as usual.
The transfer of responsibilities between the vendors and management can remain confidential, while any due diligence required by funders can often be handled quickly. Work with Rangewell and we'll help direct you to lenders that can competently assess your MBO opportunity and appoint the best solicitors to perform due diligence and progress the transaction as quickly as possible.
But even if vendors are willing to sell the company at a realistic price, the biggest hurdle may simply be finding the necessary funding.
In practice, MBOs are usually funded via a combination of sources:
A buyer contribution – The management team is usually required to introduce personal funds, and funding companies consider it a measure of the team’s committed to the transaction. Managers may raise the funds by selling off assets or getting a second mortgage on their home.
Asset Refinance – leveraging against the assets in the company, such as premises property, stock and equipment can raise a high level of funding.
Borrowing – lenders may provide Unsecured Loans, repayable over three to five years, to support MBOs. A larger scale of lending and a longer-term solution may be provided by a Secured Loan, with the security provided by other business assets.
Private Equity – Private Equity firms usually want liquidity after 3 to 6 years. Their funding often includes stipulations about how the company must be run and may include financial and other objectives.
Vendor Loan – the vendor can actually help fund the transition by leaving some of their equity in the company as loans that are repaid over time. This may be stipulated by some lenders who want to see evidence that the plan is seen as fully viable by the sellers.
Financing an MBO with Staged Payments
As we mentioned in the earnout scenario above, some sellers can choose to help the buyers finance the transaction by agreeing to a staged repayment plan where payments are made from future earnings once the sale is completed.
Alternatively, some finance providers may only offer specific agreements that allow for staged repayments. These are often offered when a lender is unsure about the management team's ability to grow the business, or there are concerns that the departing owner's exit will cause disruption to clients and sales - in which case a staged repayment plan means the seller has a vested interest in ensuring the business keeps running as profitably as possible once they leave.
In both cases, staged repayment plans give the buyers more flexibility around capital requirements - but they will need consent from the seller, who may instead favour a single lump sum buyout to fund retirement or future plans.
Open negotiation is crucial, as both pre and during the sale you may find circumstances change: for example, if you've negotiated the buyout and the seller has agreed to your price, but lenders then decide to only offer a staged repayment agreement - you must then renegotiate to see if the seller will accept the new terms.
Structuring an MBO
The actual structure of an MBO will depend on the nature of the business being purchased. In many cases, the typical process is for a new company to be incorporated, which then buys the target company. Sometimes the buyer creates multiple companies, with one acquiring the business and the other acting as the funding vehicle.
In all cases, it's best to progress with an experienced business advisor or solicitor's advice on hand. They will help you identify and pursue the most efficient process for your specific team and business. We can help you appoint a legal professional skilled in MBO transactions, get in touch to learn more.
Tax implications of an MBO
The MBO process, like many business transactions, is subject to certain tax issues for both the buyers and the seller. The exact tax implications will depend on how you structure the buyout, with the most beneficial structure tending to involve the company itself buying the departing owner's shares. The buyer's holding company then buys these shares, rather than buying them directly as this would incur heavier taxes.
Again, in all circumstances regarding tax it's best to speak to an accountant or tax advisor specialising in MBO transactions to ensure both the buyer and seller benefit from the most tax efficient purchase possible. If you work with Rangewell, we'll help you find a dedicated tax advisor to help throughout the transaction.
Advisors that you need for an MBO
If you are ready to buy into an established practice or business, many lenders will be happy to lend. Your professional status will present as a good business risk, and you can easily prove the viability of an existing business with accounts and order books.
But not all lenders will be able to offer the most competitive terms or even provide the flexibility that you need. To access the best agreements, you'll need our help - we act as your financial experts to secure the best finance terms on your behalf.
Looking for the most competitive deal across the entire lending market, unfortunately, takes time and expertise. But at Rangewell, we know the lenders who can offer the most competitive rates for you, and we find solutions for all types of business finance.
We help source the entire range of conventional loan products, and Alternative Funding from new loan providers and styles of funding. Even more important when it is an MBO, we can work with you to tailor the kind of complicated ‘Jigsaw’ Funding plan you will need to support your plans.
We understand the challenges of MBOs. Call us now to get our experts working for you.
REAL EXAMPLES OF WHAT WE CAN DO
Source a Professional Loan to allow a physiotherapist to buy his employer's practice
Find the most competitive Asset Refinance deal to allow the manager of a transport company to buy out its owner
Help the management team buy an engineering company in the aerospace sector
Find Mezzanine Finance to allow the management board of a medical equipment company buy the business from the corporate owner
Produce funding for a management team to buy a bottling company
Last update: 21 February 2023
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