What are the options for funding a management buyout?

There are several options for funding an MBO, each with different features in terms of cost, risk, and availability. It is in your best interests to consider all the avenues available and to make a well-informed decision which will hopefully pay dividends long into the future.

‘Buyers of companies have become increasingly creative as to how to fund their purchases. Sometimes this creativity has arisen out of sheer necessity as, if the money is not immediately to hand, strategies need to be developed to secure it,’ says Matt Lewins, a solicitor in the corporate and commercial team. ‘Other modern funding routes have arisen out of seller desperation, where providing a funding lifeline to the buyer has been the best way for the seller to secure an exit from their business.’

Main funding options

The main funding options for an MBO can be distilled into the following groupings, and Matt takes a brief look at each in turn:

• Private equity – this route usually involves either venture capitalists, angel investors or high-net-worth individuals investing in the business in return for an equity stake so as to secure a future return on their investment. It may also involve an element of help or mentorship, and you can benefit from leverage of the investor’s contacts.
• Individual loans – in this option, each member of the MBO team takes out a personal loan (if required), which may be unsecured or sometimes secured against their own property. The liability for repayment rests with the individual members in their personal capacity.
• Leveraged finance – here the loan is secured over the assets of the company being acquired. In this sense, you could think of it as akin to buying a house with a mortgage – the asset itself is used as the means of securing the finance. The business assets are therefore at risk until the loan is repaid.
• Standard business loan – in this case, a business loan is obtained but on an unsecured basis. The liability for repayment rests with the business, but it is not secured directly against the business assets.
• Seller finance – this option can be a little more creative and is not ‘one size fits all’. For example, options include:
  • a simple deferred consideration, where the purchase price is paid over time (often from business profits);
  • seller sliding equity, whereby the seller is paid off over time and their equity stake diminishes with each tranche paid; or
  • where the seller takes a private mortgage over business property or takes some other form of security to ensure that they are paid for their shares.

The pros and cons of each option

Private equity

This option may provide you with a route to a debt-free acquisition. Although you will have to give up some equity in return, the lack of debt will give you some vital breathing space, particularly in the early stages of your purchase.

Also, if the investors can provide you with value in the form of knowledge, contacts or supply chain assistance etc., this may boost your company’s growth.

You must bear in mind with this option that the private equity market is very competitive, and investors are only looking for the very best investment opportunities. Clearly, if the business concerned has a strong balance sheet, a lengthy trading history and a prominent brand name, then would-be investors will be far more likely to get on board.

However, the main disadvantage is the need for constant reporting to investors and the ongoing requirement to meet their (often overly ambitious) growth targets. To those with an entrepreneurial outlook, who value freedom in their decision-making, having external shareholders can become limiting and tiresome.

Individual loans

The key downside here is that the MBO team are taking on personal liability, and may be putting their homes at risk, depending on the conditions of the loan. The big upside is that the buyers retain all the equity in their acquisition, so if the business thrives their investment may prove very lucrative.

Also, it is possible that the personal finance terms may be available on more competitive rates than commercial financing, particularly if first or second mortgages are taken out to secure the loans.

This option can sometimes be problematic where there are significant differences in personal wealth, individual asset base, or credit profile amongst the MBO team. For example, some members may feel they have more to lose and this could lead to issues arising in other areas of the deal, such as equity stakes, management roles and voting rights.

Leveraged finance

This option avoids personal liability for the team. However, it relies on the business owning property or other viable assets which are suitable for lending security purposes. Where that is the case, the finance is likely to be on better terms than for a standard unsecured business loan (see below), but nevertheless it will still require repayment and may place the business under a cash flow burden when it can least afford it.

Further, in circumstances where the repayment terms prove too challenging and payment defaults arise, the business may be put in a disastrous position if and when the loan is called in and the business assets are seized or repossessed.

Standard business loan

A routine method of funding that may well be straightforward to obtain, particularly if the loan is provided via the company’s existing bankers. However, as with the leveraged finance option, it may still prove a drain on cash flow.

Seller finance

This can be an excellent route for a distressed sale, or where the MBO team lack the more conventional routes to finance as set out above. The great thing about seller finance is that it can be structured to suit all parties.

If the business is loss-making or is suffering from cashflow or solvency issues, you may be able to take advantage of the situation to secure seller finance terms which may not have been available otherwise.

The seller finance option can provide a quick path to completion, which may be the overriding objective if the business is facing uncertain times, or the seller has simply had enough and is desperate to quit or retire.

How we can help

If you are considering a management buyout, then speak to our corporate and commercial solicitors without delay. We can evaluate your situation and help you identify the best way forward in terms of your MBO funding options and many other aspects of the potential transaction.

For an informal conversation, please contact Matt Lewins in the corporate and commercial team on 01732 496 461 or email on matthew.lewins@thackraywilliams.com. Thackray Williams LLP has offices in Bromley, Sevenoaks, London and West Wickham.