A guide to the importance of financing in management buyouts, how to secure the capital and the common pitfalls to avoid to ensure a smooth takeover.
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Management buyouts can arise from various circumstances, from an existing owner moving on to a significant strategic or structural shift in the company, and having the required capital for a smooth takeover is crucial. External funding can help cover transactional and legal costs while providing liquidity to keep the business moving and secure its long-term success.
We look at the ins-and-outs of securing finance for a management buyout, including the main funding options, risks to navigate and ways to ensure the buyout is a success.
A management buyout (MBO) is the process of a company’s existing management team acquiring full or partial control of the business. It can involve using the combined funds of those taking over, external funding or a mixture of both.
The buyout process and deal structure are often complex, involving valuation, organising/securing finance, agreeing timelines, meeting compliance rules and completing due diligence and risk management, plus change management considerations. The result is the transfer of ownership.
Benefits of a management buyout (as opposed to an external acquisition) include:
Choosing the right financing is crucial in management buyouts, as most require more than just the funds to cover the purchase cost. Participants need significant liquidity to manage operations and various liabilities after the takeover. Plus, consider the growth plans and long-term strategies for maintaining stability/profitability.
So, if you’re involved in a proposed management buyout, you may need additional finance to cover some or all of the following:
There are many reasons why existing employees may seek to take over from the current owners, but here are some of the typical reasons for a management buyout:
The timescale for a management buyout in the UK can vary widely, depending on factors like company size, the number of participants, deal complexity and due diligence processes. It can take between three to six months, or as long as several years, if particularly complex, with the financing element being crucial. If you have a large proportion of the funds already in place, it can reduce delays, but the amount and type of external finance needed can dictate how long the buyout takes.
So, to reduce potential delays in management buyout financing, get well prepared in advance in terms of scoping out finance options and determining how much you need, with the support of dedicated legal and financial advice.
MBOs rarely happen without external funding and may require high capital requirements. So, you’ll need to consider the main financing methods, such as debt, equity and seller finance, plus their benefits and drawbacks.
Let’s take a look at the management buyout financing options most commonly used:
If you need to source external funds for financing a management buyout, any prospective lenders or investors will want to judge your financial situation, risk level and the buyout’s viability. Here are the main things they’ll evaluate:
If you’re worried about incurring too much debt, a suitable approach for financing a management buyout is with a balanced funding mix. This can be achieved by blending short-term business loans with existing personal funds pooled between the management group. Alternatively, you can use a combination of debt and private equity finance, so you’re not overly reliant on either, i.e. not overloading monthly outgoings while not relinquishing too much equity or control.
You may also include some form of seller finance agreement, using an initial down payment and further, smaller payments made in instalments to reduce financial pressure during the buyout process.
Good working capital management, cash flow planning and smart forecasting reduce the risks of running up too much debt when using external funding. This helps you predict or prevent issues with ongoing financial and operational liabilities and provides room to grow and a buffer for any unexpected costs.
Many companies are wary of long-term external funding commitments, whether incurring a significant amount of debt to repay over time or giving up a chunk of control or future profits to an equity partner. A blended finance approach to management buyouts can enable you to reach your growth ambitions beyond the takeover, without overcommitting to external funding sources.
For example, if you need significant capital to ensure a smooth buyout process, a short-term loan can cover upfront costs with existing funds used to keep operations ticking over or support expansion plans.
Alternatively, if you have the existing funds for a takeover, a loan or line of credit could cover any overspend or unforeseen events during or after the buyout, giving you room to manoeuvre.
When judging what external funding you need in your management buyout financing structure, be aware of the pros and cons of debt and equity finance, and when it makes sense to combine the two sources. Here are the main benefits and drawbacks to consider:
Management buyout debt financing can involve the use of loans and other forms of credit lending from banks and financial institutions, or an agreement between you and the owner selling the business (seller finance).
This form of finance revolves around sharing risk, profits and control in exchange for providing a necessary injection of capital for the buyout.
In reality, a hybrid approach is quite common, as it helps to strike the right balance between risk, control and costs. Using a mixture of existing assets, external investment, or capital borrowing is often the safest way to fund the deal. A structured agreement that combines debt and equity finance is referred to as mezzanine finance.
Leveraged management buyout financing, with a mix of debt and equity finance, can speed up the buyout process, reduce potential risks and provide a more stable environment, accounting for uncertainties and challenges ahead post-buyout.
Seller financing is a way to pay for the company purchase over time without needing a third-party lender. However, while you may think cutting out the middleman means getting a deal done more easily, it’s often not the case.
As the buyer in a management buyout process, if you use selling financing, there’s a risk of losing leverage, with the negotiations favouring the existing owner, who may demand certain obligations and costlier terms. While borrowing capital or having equity investment can push through a buyout, seller financing can result in lengthy negotiations and unclear conditions. Also, it can be tricky to structure the deal.
There are also downsides for the seller, such as buyer default risks and potential disputes down the line (say, if any payments are dependent on business performance).
Essentially, if you’re going down this route, both sides need to get extensive legal and financial advice to ensure neither party gets a raw deal or is exposed to unnecessary risk in the arrangement.
Management buyouts are complex, and their financing comes with various challenges to ponder if you want to avoid running into trouble, including:
Alternative finance providers (many of which offer fully digital lending) can help you overcome the challenges mentioned. While traditional lenders/banks typically have longer application/approval processes, stricter eligibility criteria and more rigid lending conditions, alternative lenders often offer faster and easier access to funds, with more flexibility for navigating cash flow and time pressures or eligibility hurdles.
A leveraged management buyout is when a significant proportion of the business purchase is funded by capital borrowing, which may require personal guarantees or assets used as collateral to secure the capital. The rest of the buyout is funded by existing equity of the management group or external investment.
You should have a clear strategy for managing debt post-management buyout, with robust cash flow planning, monitoring and forecasting vital for success. Plus, you need to prioritise your repayments to any financial lending agreements you enter into as part of the process.
Flexibility in your finance agreements can ease pressure when planning and facilitating a management buyout, whether it’s variable interest rates, options to top up funds (as in a revolving credit facility) or flexible repayment terms (with the option to make early repayments).
For example, with an iwoca’s flexible business loans, you only pay interest on the funds used, you can draw down capital as and when required within 30 days after approval (with the option to top-up* as your business grows), and there are no early repayment fees.
*Credit top-ups are subject to approval.
Change of control clauses are contractual terms that give the company’s existing clients, suppliers, lenders, etc., the option to alter or even terminate agreements in the event of ownership change. In the context of a management buyout, this can throw potential spanners into the works. It may mean you need to renegotiate certain contracts or agree to new ones elsewhere.
The impact may be unexpected costs, inflated prices (if new deals need to be struck), potential lender or supplier concerns, and continuity issues that cause friction.
Here are a few ways to reduce potential issues with change of control clauses:
The post-buyout period needs to be handled carefully. Leadership changes can cause friction and cultural impact. So, clear and inclusive internal communication is vital to reassure staff and motivate them about the future direction of the business.
If you have a new vision and key priorities to focus on, look to manage necessary change with clarity and empathy. If you need to realign roles or restructure teams, it may mean implementing certain rewards and incentives.
This is where your buyout financing strategy plays a key role. By sourcing funds for post-management buyout requirements, which have a good level of flexibility, you can enjoy cash flow agility to make necessary staffing changes, promotions or benefits. This shows your intention to invest in your people, helping you retain your top talent.
Iwoca Flexi-Loans can be used to support and accelerate management buyouts, offering flexible repayment terms tailored to your needs, and fast access to finance (without lengthy applications or heaps of documentation). Borrow up to £1 million for a few weeks right up to 60 months, only paying interest on the funds you draw down. Plus, we don’t charge early repayment fees.
Check out how to get a business loan with iwoca and use our repayment calculator to work out your likely monthly repayments.
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