Management buyouts: funding options

Getting the finance in place to enable a management buyout to proceed can be challenging for the management team. There will be a number of people involved in the decision-making process, all of whom will have differing levels of experience, personal financial security and appetite to risk, and all of whom will be trying to pull a deal together while still doing their day job. In these circumstances, it is essential for the business owner and management team to work together to get the buyout arrangement over the line.

In the final instalment of a three-part series of articles on management buyouts, we provide a brief overview of the main funding options for the management team.

Click here to view the first article, which looks at management buyouts from the business owner’s perspective, and here to view the second article, which looks at the matter from the perspective of the management team.

Personal funds

Depending on the agreed purchase price, how many people are involved in the buyout and the state of everyone’s finances, it may be possible to bankroll the buyout from personal funds. However, where this is an option, consideration will need to be given to the amount each member of the management team is able to contribute, how uneven contributions will be reflected in the ownership of the business and the consequent rights of return on investment. An agreement will need to be reached to determine what should happen in the event personal circumstances change and money put into the business needs to be withdrawn.

Traditional finance

The use of bank loans may be a possibility and there are lenders in the market who are willing to provide finance to facilitate a management buyout. From the lender’s perspective, they may take comfort from the fact that the people they are lending to are already involved in the business and will therefore be able to hit the ground running when the buyout occurs.

However, many lenders willing to back such a deal will expect the management team to demonstrate their commitment to the business, and indeed their willingness to shoulder some of the risk if things go wrong, by contributing money from their personal funds as well. It is unlikely that the use of loans will be sufficient to cover 100 per cent of the buyout costs.

Venture capitalists

Venture capitalists may be an option, although they tend to prefer the bigger ticket sales and may well have plans for the business which differ significantly from those of the management team. They may also insist on appointing someone of their choice to the management board, and while the right person may contribute a great deal to the business via their skills, experience and contacts, the wrong person can bring an unwelcome change in dynamics. This is something the management team may be uncomfortable with and which may, ultimately, frustrate attempts to steer the business in the management team’s preferred direction.

Owner-backed arrangement

In appropriate cases, it may be possible to ask the current owner of the business to help finance the deal through what is known as a ‘deferred consideration’ arrangement. This may be possible where, for example, the current owner is prepared to accept part of the agreed purchase price at the point of completion and the rest when certain milestones are reached or events occur. It may also be possible where the owner is prepared to accept something other than money as a form of payment; for instance, an agreement to assume liability for a debt or some other obligation.

Where deferred consideration is a possibility, legal advice should be taken as soon as possible to ensure that a viable back-up plan is in place to cater for what should happen if the arrangement fails. What will the consequences be if, for example, an agreed instalment payment is missed? Will the management team be given a chance to put things right, or will the business automatically revert to the previous owner, or perhaps even transfer to a third party?

These are all things you will need to think about and discuss with your solicitor before the final details of your buyout plan can be agreed.

For help with a management buyout, or any other corporate transaction, please contact us.