How MBO funding works

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What different types of finance available for an MBO?

The financing of a management buy-out (MBO) can be achieved through various methods, contingent on the specifics of the transaction and the financial resources available.

Here are the primary avenues for MBO financing:

Management Contribution
The MBO team is typically expected to invest their savings or personal capital in financing a portion of the MBO. This may involve utilising private funds, savings, or assets as equity contributions to the transaction. While it may not constitute the most significant part of the funding structure, it demonstrates the management team’s commitment to the MBO’s success. It aligns their interests with those of other investors. The amount can vary but often encompasses up to 12 months’ salary per MBO team member, with an additional sum to cover deal-related expenses. In some instances, equity from existing minority shareholdings of MBO team members may be rolled into the transaction, forming part of their commitment.

Surplus Cash
Many businesses accumulate surplus cash balances over time, which can be extracted after the MBO. This is often a more tax-efficient way for vendors to receive funds than historical dividends. The value of the company will include surplus cash.

Debt Financing
Debt financing is essential to MBO funding. The amount of debt a business can take on is determined by its financial forecasts, assets, and available cash flow to service the debt and provide working capital. Debt options may include:

    • i) Senior Debt: Cash flow loans, typically 2 to 2.5 times EBITDA.
    • ii) Asset-Based Lending: Utilising the business’s assets, including property, stock, debtors, and fixed assets as collateral.

Vendor Finance / Deferred Consideration
In some instances, the current owners or shareholders of the company may provide financing to the management team. This is known as vendor financing or deferred consideration. The terms of seller financing, including interest rates, repayment schedules, and collateral, are negotiated as part of the MBO transaction. This often serves as the “balancing figure” to facilitate smaller deals. Repayment of vendor loans may be limited until senior debt is repaid or reduced to a level where vendor loan repayment does not unduly strain senior debt repayment.

Unlike deferred consideration, earnouts involve contingent payments based on the future performance of the acquired company. In an MBO, the management team may negotiate earnout arrangements with the current owners or shareholders, with a portion of the purchase price linked to achieving specific performance targets post-acquisition. Earnouts can bridge valuation gaps and align the management team’s interests with those of the current owners.

External Equity Financing
When debt and deferred consideration are insufficient, an MBO team may seek external equity financing from private equity firms, venture capital firms, or other investors. These investors provide equity capital in exchange for ownership stakes in the company, often bringing 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 funded by combining the above sources. Corporate finance advisers work closely with individual funders to determine the most suitable blend of funding for each transaction.

Banks typically play a limited role in MBO transactions, primarily in more substantial deals with an EBITDA of at least £2 million. Banks have limited resources for analysing such transactions and are considered higher-risk endeavours. Most MBOs rely on independent finance providers that offer more flexibility and a more robust appetite for such transactions. Therefore, MBO teams should not assume it’s impossible to secure bank support merely because the bank lacks the appetite.

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