How do we finance an MBO?
There are several ways to finance a management buy-out (MBO), depending on the circumstances of the transaction and the available financial resources.
The MBO team will be expected to use their savings or capital to finance a portion of the MBO. This can include using personal funds, savings, or other personal assets as equity contributions to the transaction. Whilst not the most significant part of the funding structure. This demonstrates the management team’s commitment to the success of the MBO and aligns their interests with those of other investors. The amount will differ from deal to deal, but standard guidelines are up to 12 months of salary (per MBO team member) with enough to at least cover deal costs.
Sometimes members of the MBO team may well already have a minority shareholding. Some lenders will allow this equity rollover into the transaction to be part of the MBO team commitment.
It is common for a business to have built-up surplus cash balances. These are typically extracted at completion as it is more tax efficient for a vendor to take as capital than historically through dividends. The company value will include surplus cash.
Any business can only take on a specific debt capacity based on financial forecasts. This will be a function of the company’s assets and available cash flow to service the debt and provide working capital.
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Debt alternatives are:
i) Senior Debt – Cash flow loans are typically 2 – 2.5 times EBITDA.
ii) Asset Based Lending against the business’s assets, including Property, Stock, Debtors and Fixed Assets.
Vendor Finance / Duration:
In some cases, the current owners or shareholders of the company being acquired may provide financing to the management team. This is known as vendor financing or deferred consideration. The terms of the seller financing, including the interest rate, repayment terms, and collateral, are negotiated as part of the MBO transaction.
This often becomes the “balancing figure” to get a deal away in smaller deals.
But many lenders will restrict repayment of vendor loans until their debt is repaid or reduced to a level that vendor loan repayment doesn’t put an undue strain on senior debt repayment.
Whereas deferred consideration is fixed, earnouts are contingent payments that are based on the future performance of the company being acquired. In an MBO, the management team may negotiate earnout arrangements with the current owners or shareholders. A portion of the purchase price is paid based on achieving specific performance targets after the acquisition. Earnouts can provide additional financing to bridge valuation gaps or align the management team’s interests with those of the current owners.
External Equity Financing:
If a transaction can’t be obtained by debt and deferred, an MBO team may seek external equity financing from private equity firms, venture capital firms, or other investors. These investors typically provide equity capital in exchange for ownership stakes in the company. They may also bring strategic expertise, industry knowledge, and networks to support the MBO and add value to the company post-acquisition.
Combination of Financing Methods:
Most MBOs are financed through a combination of the above funding sources. Corporate finance advisers will liaise with individual funders to introduce the most appropriate blend of funding for each transaction.
The role of the banks in MBO transactions is generally limited to the more significant deals with an EBITDA of at least £2m. This is due to the banks having limited resources in analysing deals of this nature and the fact that such transactions are at higher risk.
Most MBOs arranged by ourselves rely on something other than bank funding as there are more flexible independent finance providers with more of an appetite than the high street bank. So any MBO team enquiring to the incumbent bank for support shouldn’t assume it is impossible just because the bank doesn’t have the appetite.