Funding a Management Buy Out (MBO)

Author(s)
David Wisbey

Selling a business to its existing management is one of the most popular solutions for a business sale, but the success of the deal will depend on whether the management team can raise the funds required to pay for the business.

There are three principal sources of funding for a management buyout: first, the traditional route of borrowing from a bank; secondly, funding may be available from an external investor, such as a private equity fund or an individual investor; and thirdly, the seller of the business can provide some of the funding, by agreeing to delay payment of part of the price (sometimes referred to as “vendor debt”). None of these sources needs to be exclusive, and it is quite common for funding to be obtained from any combination of the three.

Despite the loss of liquidity in the banking sector caused by the “credit crunch”, banks are still prepared to lend money to help with the funding of an MBO where the target business has sound finances and good quality management. The amount that can be borrowed will depend on a number of factors, including the presence and extent of existing bank facilities in the target business, and the nature of the security available to support the borrowing.

We have advised on MBO’s where the bank lending has been supported by security in a variety of forms, from specified assets of the target business, such as printing machinery, to wide ranging security over all of the assets of the target. Funding can also be obtained on the strength of the debts owed to the business by customers; “invoice financing”, as this is called, is a popular way of assisting with the funding of an MBO.

External investors have historically been an important source of funding for MBO’s. They can bring with them not just the cash invested, but also management expertise, and it is common for the investor, or a representative, to join the board of directors of the buyer. The main disadvantage of bringing in external investors is that they will want to participate in the share capital of the buyer, and this has the effect of diluting the amount of the company owned by the management team.

As with the banks, external investors are still happy to fund MBO’s, despite the current economic conditions. Again like the banks, sound underlying finances and strong management in the target business are essential to any investment. Also, private investors will usually want to see good growth prospects for the business over the short to medium term.

Vendor debt is a key advantage of a management buyout, because of the flexibility that it offers. The duration and frequency of the repayments to the seller of the business can be tailored to fit in with bank funding, for example, by providing a gap in payments in the early months. The seller will want security for the debt, but again will typically be flexible enough to let the bank have priority.

Written by David Wisbey, Head of the Commercial Department at Birkett Long LLP. David can be contacted on 01245 453817 or email david.wisbey@birkettlong.co.uk

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