Structure Your Management Buyout Confidently: Secure the Right Financing

A management buyout can be an excellent opportunity for the existing leadership team to take on ownership of a company, or for the current owner to sell the business to a management team that has the company’s best interests at heart. 

But for this purchase to achieve its goals, you’ll need the right management buyout structure and finance to fund the deal.

Let’s look at what a successful buyout looks like and how the management team can raise the required funds to purchase the existing company.

Why does your management buyout structure matter?

For a management buyout (MBO) to succeed, it’s important to plan ahead and achieve a structure that meets the goals of both seller and buyer. 

• As the current owner, you’ll want the business to be secure and able to grow, securing your legacy. You’ll also want to achieve a sale price that allows you to hit your own personal goals, whether that’s a comfortable retirement, or liquidising your assets to fund a new business idea or personal project. 
• As the management team, you’ll want to know you’re taking on a viable enterprise with a sound future. You’ll also want to pay a competitive price, leaving enough funds to invest in updating and growing the business – not to mention ensuring that the company can generate revenues and drive a profit.

There are many ways that poor planning, a bad MBO strategy and poor oversight of your key goals can end up sabotaging your MBO.

For instance:

• A poor structure: Poor structure can quickly sink a promising deal. Common pitfalls can include taking on too much debt, unclear valuations that set an unrealistic idea of the sale price, and unbalanced incentives that lead to the motivations and rewards for the buyer and the seller being misaligned.
• Failing to make the transition smooth: A well-structured MBO should support  a smooth transition of ownership from seller to buyer. It’s also vital to protect business continuity, so the company can continue trading without any issues, and preserve employee morale, so your team is on board with the MBO.
• Not addressing the key concerns: Both sides in the deal will have concerns ahead of the MBO. Failing to address the legal, financial and cultural alignment questions ahead of the deal can lead to snagging issues, disruption and the possible undermining of what could have been a successful MBO.
• Not combining the right elements in your MBO strategy: An effective MBO will factor all key structural elements into the planning and strategy for the deal. This means getting things like the right financing mix in place, agreeing on a workable timeline for the buyout, making sure the important governance tasks have been completed, and agreeing on the fundamental terms, conditions and price for the deal.

How do I know if my business is suitable for a management buyout?

Not all businesses will be suitable for an MBO. Before you consider the possibility of a buyout, it’s crucial to check your eligibility as a business, including the nature of the team in place, the state of the business and the financial resources available.

To be suitable for an MBO, you’ll need:

1. A strong, committed management team: It’s essential to have an experienced top team, with a clear vision and the willingness to invest in the future growth and development of the company.
   
   
2. To be a profitable, viable business: Good revenues and consistent cash flow are vital. A solid financial position proves your ability to handle debt and fund growth, reassuring lenders and potential future investors.
   
   
3. Realistic seller expectations: You’ll need to be flexible on price and terms to make the MBO work. The priority has to be a successful handover and the continuing success of the business, not achieving an unrealistic sale price.
   
   
4. A clear strategic rationale: The buyout is just the start of your strategy. You’ll also need a detailed post-acquisition plan that demonstrates an understanding of your market position, growth potential and ability to attract investment.
   
   
5. Feasible financing options: The company will need a sustainable capital structure, combining equity and debt, to ensure the viability of the deal and the longer-term financial health and potential of the business.

How to choose the right financing structure for your management buyout

The right finance structure for the circumstances of your deal is fundamental to the success of your MBO. 

There are many different ways to access the required funds for the buyout, but it’s important to understand the pros and cons of each finance option – and how each specific option may impact on your longer-term goals as the new owners. 

Let’s dive into four of the most popular ways to fund your MBO.

Senior debt

Senior debt is a kind of finance where repayment of the debt is prioritised if the company were to go bankrupt. The reduction in risk for the lender can result in lower interest rates, making this type of finance cheaper to repay.

• Pros: Retains maximum management control (no equity dilution). It’s often the fastest option to secure and generally the cheapest form of capital. Some flexibility in repayment schedules can be attained, depending on the lender.
• Cons: Can be rigid with covenants and security requirements, potentially restricting your operational flexibility. Senior debt can result in a high ratio of debt to equity or assets for the company. The funding may not be sufficient to fund the entire buyout and could require supplementary financing.

Mezzanine finance

Mezzanine finance brings together both private equity and standard loans. bringing in fresh capital that isn't secured against assets

• Pros: Mezzanine finance is more flexible than senior debt in terms of repayment and covenants. It can help to bridge the gap between senior debt and equity, reducing your upfront equity needs. The lender may benefit from warrants or equity kickers. These offer the lender a slice of the company's future equity, if the business grows and share prices increase etc.
• Cons: Mezzanine finance is more expensive than senior debt. As the borrower, it involves some dilution of your future equity through warrants. It can be slower to arrange than senior debt. Mezzanine finance sits in a subordinate position to senior debt, increasing the potential risk for the provider.

Seller financing

Seller financing is a financial agreement between the seller of a business and the buyer. The buyer provides a deposit to secure the purchase, then pays the remaining amount in instalments to cover the full price of the deal. 

• Pros: Seller financing can be faster and more flexible to arrange as terms are negotiated directly with the seller. It also helps to align the seller's interests with the buyer's post-acquisition success. It’s a good way to reduce the need for immediate large cash outlays for the buyer.
• Cons: Seller financing can impact management control if the seller retains significant influence or security. It may be costly, depending on the interest rate and terms agreed with the seller. The seller may also want to be involved in future business decisions, which could cause disruption.

Equity financing

Equity financing can provide funding injections by selling shares in the business to private investors or private equity companies. This helps you access further capital, but does mean handing some level of business control over to your investors.

• Pros: Private equity injections can provide significant capital, which could lead to faster completion of the MBO. By working with private investors, you can also bring valuable expertise and networking opportunities into the business. It offers flexibility in terms of repayment (as it's not debt).
• Cons: Results in significant dilution of management's equity and loss of control. Can be the most expensive form of financing. The process can be slower and more complex due to due diligence and negotiation. Can introduce external influence on your strategic decisions, going forward.

What’s the best way to structure financing for a management buyout?

Structuring your MBO financing depends on the size and time frame of the deal. Using a mix of finance options – such as senior debt, mezzanine finance, seller notes and equity in proportions that match your deal size and cash‑flow profile – can provide the flexibility to close the deal and fund growth in the long term. 

For managing working capital before, during and after the transition, iwoca  Flexi-Loans can provide up to £1m in fast, transparent funding, which you can repay early with no extra fees.

Structuring a management buyout to minimise risk and debt

It’s sensible to maintain a healthy debt-to-equity balance within the business, so debt doesn’t become an issue, or have a negative impact on your credit score etc. This also helps to minimise risk, by keeping debt within manageable levels. 

Key ways to minimise risk and debt will include:

Avoiding over-leveraging 

Fund your acquisition of the company with a significant equity contribution from the management team and, potentially, through private equity. 

This reduces your reliance on debt and the subsequent burden of repayment. Aim for a sustainable debt-to-equity ratio. A conservative debt-to-equity ratio would ideally be around 1:1 or lower, but this ratio will be dependent on your industry and unique circumstances as a business. 

Spread the repayment pressure 

Negotiate longer loan terms, with flexible repayment schedules that align with the company’s projected cash flow. These repayments could incorporate balloon payments to ease the initial financial strain.

Stepped payment deals 

Structure the acquisition with initial lower payments followed by larger amounts that are contingent on the business achieving specific future performance milestones. Using stepped payments in this way reduces your upfront financial risk.

Hybrid financing models 

Combine different financing instruments – like senior debt (lower risk), mezzanine finance (with equity kickers), and seller financing – to diversify your overall risk and reduce reliance on any single high-debt source.

Significant earn-outs

Tie a substantial portion of the purchase price to the future performance of the business under the management team's ownership. This shifts some initial risk to the seller, and acts as an incentive to improve performance post-MBO.

Maximising seller financing 

Encourage the seller to finance a portion of the deal, so their interests are aligned with the ongoing success of the business. Going the seller finance route can potentially offer more flexible terms than going to external lenders.

Asset-based lending

Use asset-based loans secured against specific assets in the business, like equipment or property. Potentially, this can allow for higher borrowing capacity with less overall business leverage, as long as there’s a strong asset base in the business.

Focus on operational efficiency

Create a clear post-acquisition plan aimed at quickly improving profitability and cash flow. By boosting revenue, cash flow and your bottom line, you’ll have stronger financial foundations for servicing any debt you’ve taken on.

Overcoming valuation disagreements in your management buyout structure

Buyers and sellers can often disagree on the future growth expectations of the business, or what a ‘fair’ market price is for the existing company.

To overcome these discrepancies, make you carry out an independent valuation of the business and include deferred consideration and earn-out clauses within the deal.

Legal support is essential, providing you with clear documentation and agreements if disputes do arise further along the MBO journey.

Flexibility in financing can also help bridge valuation gaps. For example, using seller financing or top-up options as incentives to sweeten the deal. 

How to effectively use debt financing in a management buyout structure

In most management buyout scenarios, it’s rare for the members of the management team to have enough liquid capital to fund the entire buyout. To overcome this lack of ready capital, MBOs will make use of debt financing, using borrowed capital to fund the acquisition of the company.

Working up debt in the business can be a serious risk, so it’s good practice to have a clear debt financing strategy and excellent financial management skills. 

Here’s how to make debt financing work for your MBO:

• Senior debt is the cornerstone: Senior debt will typically provide the largest portion of MBO financing. This is due to its lower perceived risk for lenders, secured against the company’s assets. However, excessive reliance on senior debt can create significant repayment obligations and a drain on cash flow.
• Balance leverage with cash flow: High debt can help to boost your returns on the deal, but can also put a strain on your post-deal cash flow. Positive cash flow is needed to finance your operations, growth and cover any unforeseen issues. So, it’s sensible to balance debt usage carefully against your ongoing cash position and cash runway. 
• DSCR dictates viability: Your Debt Service Coverage Ratio (DSCR) must be robust. This DSCR score is worked out by dividing EBITDA or cash flow by your debt service figure. A low DSCR signals high default risk, which could hinder your future investment potential and operational flexibility.
• Short, scalable, no prepayment fees: Short-term debt can reduce the risk of long-term interest on a large loan. Scalability means your debt can be adjusted (increased or decreased) over time, in line with the growth or changing financial needs of the business. Having no early repayment fees means you can pay off the debt early, if your cash-flow situation permits, reducing debt further.

Making use of short-term loans from a provider like iwoca is one way to reduce your risk level and keep debt at a manageable level. An iwoca Flexi-Loan offers fast access to funds, repayments on your terms and interest only on the funds you draw down.

Negotiating seller financing in your management buyout deal

As we’ve seen, seller financing can be a highly beneficial funding option when you’re considering routes to finance for a management buyout finance mix.

With seller finance, the current owner of the business accepts deferred payments over time for the value of the business. This allows the management team, and new owners of the business, to gradually repay the funding over an agreed timeline. 

Lets look at some of the main pros and cons of seller financing:

• Pros: seller financing is quick to set up, which helps to keep the deal moving. It also aligns the motivations and incentives of the seller (the current owner) with the buyer (the management team and incoming owner). 
• Cons: the ongoing repayments can potentially put a strain on your post-deal cash flow. Seller finance deals can often be informal, so it’s important to make sure the deal and the finance arrangements are properly structured

Make sure the deal is signed off by professional advisers and that you have clear timelines, performance conditions and legal safeguards in place as part of the governance of the wider deal. 

As part of your funding mix, it’s helpful to explore flexible financing, like an iwoca Flexi-Loan. A Flexi-Loan can supplement your seller finance as part of your ongoing MBO, so you’re not reliant on a single funding stream.

How long does structuring a management buyout typically take?

Structuring an MBO can take several months, often ranging from three to nine months from the start of the initial discussions, through to the final closing of the deal. The timeline will vary depending on the complexity of the business, the availability of financing, and the speed of negotiations and due diligence. 

Sellers will need to be fully involved in the MBO process, providing information and negotiating terms. Buyers (the management team) will need to dedicate significant time to securing financing, conducting due diligence and negotiating the legal and financial aspects of the acquisition. 

An MBO can be demanding, so it’s best to be aware of the complexity, time commitment and detailed planning that’s required from the outset. 

Managing 'change of control' clauses in your management buyout structure

During a management buyout, change of control clauses are used to protect the interests of various parties within the deal. These clauses outline what happens when there's a significant change in ownership or control of the target company. 

Change of control clauses often grant certain rights or obligations when certain events occur; for example, if the agreement is terminated, the asking price changes, or the deal is renegotiated etc.

When reviewing the legal documentation, look out for changes of control clauses, so you understand exactly what you’re signing.

Be aware that:

• Clauses can often be buried in commercial leases, supplier contracts, or loan agreements, so be sure to read all the small print.
• A pre-deal contract audit by an experienced MBO lawyer is good practice, helping you to avoid any nasty legal surprises further down the line. 
• Keep the communication between all partners involved in the deal open and transparent. And be open to renegotiation of the deal and the legal and control impacts this may have. 

Making flexible small business loans part of your finance mix, is one way to speed up the MBO process and reduce your reliance on senior debt or seller finance – both of which could trigger restrictive clauses if the deal needs renegotiation.

How to ensure easy integration after structuring your management buyout

You’ve completed the MBO deal, and the company is now owned and run by the existing management team. But that’s not the end of the process.

A change of ownership can have far-reaching consequences, both within the business and among your wider network of customers, suppliers and external stakeholders.

To keep things running smoothly, focus on:

• Maintaining and updating the company culture: Switching from the previous boss to a business that’s run by the management team can have a significant impact on the culture in the company. Be open and transparent about the kind of internal and external cultures you want to support.
• Boosting staff confidence: Going through an MBO process can be unsettling for the whole team. Make sure your people know the business is safe, their jobs are secure and there’s a bright future for the company.
• Realigning your business strategy: New leadership can often lead to a new overriding strategy for the business. Define your vision, your plans for growth and the key strategic goals you have for the business over the coming months.
• Keep communication open and honest: Have regular all-hands meetings with your team to communicate your new vision, share details of performance and outline the goals the company is working towards.
• Review and manage your finances and debt: Keep a razor sharp focus on the company’s cash flow position, debt position and the overall financial health of the company. Managing your MBO debt will be a key responsibility as the new owners.

iwoca: flexible finance to reduce the risk for your MBO

Managing cash flow and covering the costs of your post-MBO operations is easier when you have access to fast, effective and highly flexible funding.

A Flexi-Loan from iwoca helps you borrow from £1,000 to £1 million, giving you the funding you need to support new marketing campaigns, hiring new people and updating your systems and equipment to make the business competitive.  

Take out a Flexi-Loan and make your capital more flexible.

Apply for a Flexi-Loan today

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