Funding a Management Buy-Out (MBO)

What is a management buy-out and how is it funded?

A management buy-out (MBO) involves the sale of a business to its management team, and can occur in a number of scenarios. The team may have been mentored from an early stage with an MBO in mind, or perhaps managers’ unique understanding and knowledge of the business makes it an obvious option when a business is placed for sale.

Funding a management buy-out can be complex, however, and generally involves a mix of debt and equity finance in addition to personal investments from the team taking over. But before we look at funding an MBO, what are the main elements of this type of business purchase?

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Key features of an management buy-out

The management team

A strong management team committed to the process is a key characteristic of an MBO. Funders will consider the team’s cohesion, as well as looking closely at the skills and experience of existing team members. This may include a chief executive, and heads of sales, operations, and finance.

Vendor

Common reasons why vendors opt for a management buy-out include confidentiality of process, a smoother transition, continuity of business, speed of sale, and confidence in the purchasers.

Business plan

A detailed business plan is crucial to the management buy-out process, and will be prepared by the management team and their advisors. The document should explain how the company will repay its financiers, reliably projecting cash flows, sales, and profits over the forthcoming years.

Faster due diligence process

Given the management team’s in-depth knowledge of their business, due diligence may be limited to that undertaken by the financiers. This speeds up the process as a whole, and enables a smoother purchase.

Another crucial aspect of a management buy-out is the funding ‘package’ on which the transaction relies.

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Funding a management buy-out

Financing for a management buy-out can be a complex process involving diverse methods of funding. These can generally include personal investment by the management team, asset finance, bank debt, vendor financing, and private equity (PE). 

Personal investment

The introduction of personal monies to an MBO demonstrates commitment by the management team, and offers external funders greater confidence in their investment. The amount of personal investment required varies depending on individual circumstances, but generally speaking funders may be looking for 6-12 months annual salary from each team member.  

Asset finance

Asset-based financing for an MBO involves leveraging the value of company assets. Depending on the type of business, this form of funding might include plant and machinery, commercial property, or the company’s sales ledger. The loan is secured against one or more of these assets, and offers enhanced liquidity for the business.

Bank debt

Traditional bank lending in the form of term loans with fixed repayments of capital and interest commonly form part of the funding mix in a management buy-out. This may be a preferable option for businesses where strong cash flow can be confidently predicted.

Vendor financing

The seller may be willing to provide financial support for the MBO in the form of vendor funding. This could involve vendor loan notes repaid by the company over an agreed period of time. An earn-out agreement with the vendor, whereby they’re paid in proportion to business success following the buy-out, may also be a possibility.

Private equity

If considerable growth is anticipated and the management team are planning an exit relatively quickly, private equity investment can boost funding. Also known as mezzanine funding, this form of finance is a combination of debt and equity - private equity investors receive interest on their money as well as benefitting from the company’s capital growth.

What are the advantages of a management buy-out?

If you are considering a management buy-out or would like further information, Real Business Rescue can help. We’re a major part of Begbies Traynor Group, the UK’s largest professional services consultancy, and offer free consultations to establish your needs.