Management buyouts –what are they & how do I finance one?
Many businesses go through periods when cash is tight. Some companies have fluctuating sales cycles that make this problem a regular occurrence. But no matter if this issue is a one-off event or a frequent situation, the lack of working capital to fund everyday operations and spur growth is not good for any type of business. Fortunately, there’s a solution to short-term financial stress – meet the working capital loan – quick, simple, flexible, it’s the easiest way to keep your business running at full speed.
What is a management buyout?
A management buyout, or MBO, involves the purchase of all or part of a company by its existing management team, usually with the help of external financing. In most cases, the management team takes full control and ownership of the business and the old owners retire or move on to other ventures.
The most common reasons for an MBO are:
- The old company ownership wishes to exit the business.
- A parent company wishes to divest itself of a subsidiary or a business division.
- The company is in distress or has gone into receivership, but still has potential.
- The management team perceives greater business opportunity under new ownership.
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How does a management buyout (MBO) work?
Typically, an MBO will take up to six months to complete. It can be a complex activity, requiring the input of lawyers, analysts, and accountants, as well as the support of funders, lenders, and possibly equity investors.
From start to finish, an MBO works like this:
- The owner(s) wish to sell all or a part of the business.
- Members of the existing management team – C suite, board seats, employees – choose to buy the business.
- Buyer and seller agree the sale price. This may require an independent valuation.
- The management team assesses the amount they can invest. This sum comes from their personal assets and typically, it is only part of the sale price. Further funding is usually required.
- Detailed financial analysis is conducted. This includes creating a forecast financial model to reveal the serviceability of any debt and the potential returns for investors.
- The buyout team approaches funders. This may involve one funder, or for larger transactions, a syndicate of funders.
- Funders provide the cash to complete the sale.
- The transaction closes.
- The buyout team takes control of the business.
Financing a management buyout is often the most difficult step in the purchase process. There are multiple ways to fund an MBO and cash, debt, and/or equity investment may all play their part. Asgard funding resources can provide the expertise and advice you require to complete your MBO. Register with us to discover which funding routes are best for your transaction.
What’s the difference between a leveraged buyout (LBO) and MBO?
An LBO, or leveraged buyout, is much the same as an MBO – the business management team buys all or part of the business from the current owners. However, in an LBO, the company’s existing assets are sold or pledged as collateral to raise some or all the purchase cash.
This process is similar to the popular lease-back financing model. In a lease-back, a company will sell a hard asset, such as a building, to raise funds. It will then lease the same building back from the new owner. This allows the company to monetise non-performing assets to raise funds for operations, but still have the asset available for business use.
In an LBO, this type of lending is called asset finance. The buyout team leverages the value of assets such as property, plant, or machinery, to borrow money to buy the business from the outgoing owner. The new owners will still be able to use those assets, but they will now make repayments and pay interest until the loans are satisfied. An LBO reduces the asset value of the business as it simultaneously increases the debt burden.
Confused? Our pool of experienced lenders can advise you on the most appropriate form of funding for your transaction. Register with Asgard to find out if an LBO is suitable for you.
What’s the difference between MBI, MBO, and BIMBO?
No matter if an MBI, an MBO or a BIMBO is used to purchase a business, the outcome is still the same – new management takes over from old. However, there are differences between these purchase models:
Management buy-in (MBI)
In an MBI, a third-party team from outside the company buys the business from the current owners to become the company’s new management. They usually replace the existing management in key roles. This makes an MBI different from a simple trade sale, where a buyer purchases the business, but leaves the existing management team intact. Management buy-in teams are sometimes called ‘turnaround teams’ and they will often compete with other potential purchasers for the business. This may produce a better sale price for the outgoing owners.
Buy-in management buyout (BIMBO)
A BIMBO is a hybrid purchase transaction. It incorporates elements of an MBO and an MBI. In a BIMBO, outside managers join with existing inside managers to buy the company from the outgoing owners. The outside managers buy-in, whilst the inside managers buy-out the old owners. It is a purchasing partnership between the existing management team and a new management team. A BIMBO can reduce the amount of external borrowing required, as the pool of purchasers is increased. It can also bring in new talent that enhances the business proposition to potential funders.
What are the tax implications of a management buyout?
An MBO is a complex transaction and all too often, the buyout team will be too busy pushing the deal through to consider the tax implications of their purchase. It is only later, when they go to cash out from the business that they realise their mistakes.
Establishing the correct ownership structure at the time of the MBO is essential to capture this valuable saving.
Register with Asgard to discuss your MBO structure before you finalise the purchase with the seller. Your potential tax savings could be significant.
How do I finance an MBO?
The most difficult part of any MBO is funding the transaction. It is rare for the buyout team to have enough liquid capital to buy the business for cash, which means there is usually a need for external funding. The most popular routes to secure this money are:
Members of the buyout team use unsecured and secured personal loans to fund the MBO. For secured lending, team members will provide their homes, pension plans and other non-cash assets as collateral The loans may take the form of equity release mortgages, bank loans, or finance company loans. Good credit references are usually essential and, as with all secured lending, these assets are at risk should the business fail after the MBO.
Business loans from bank or finance companies may be obtained to fund the transaction. Depending on the track record and the type of business being purchased, unsecured lending may be possible. However, unsecured lending is generally much smaller than secured lending and, in many cases, the lender will take a lien on the company and all its assets, including its sales ledger, to secure the borrowing. Loan terms are typically 3 to 5 years.
Asset based lending
Leveraging against the assets in the company, such as property, stocks, or debtors. If the business owns substantial assets, those assets may be used as collateral for borrowing. This type of arrangement is called a leveraged buy-out, as the company’s assets are leveraged to buy out the old owner. With an LBO, the balance sheet’s liability burden will increase at the same time as its asset base reduces. The business will usually retain full access to the assets during the term of the loan.
Private equity (PE)
A steadily increasing source of finance even at the smaller end of the market. Cash is provided by venture capitalists, hedge funds and private investors in exchange for shares, board seats, dividends, fees, and varying degrees of control. This source of funding can be harder to obtain, but it can offer the chance to scale up as the company grows. Many VC and equity lenders will have an exit strategy that sees them liquidating their position in 1 to 3 years. The management team may need to find replacement funds at that point. They will also repay the lender based on future valuation. If the business has seen growth, this may mean the sum repaid is substantially larger than the sum invested.
A hybrid of debt and equity financing that gives the lender the right to convert to an equity interest in the company in case of default, generally, after venture capital companies and other senior lenders are paid.
Also called vendor loans. The seller helps to fund the transaction by leaving some of their consideration in the company as loan notes to be repaid over time. In effect, their ownership reduces over an extended period. The old owner may retain a degree of control until they are completely paid out.
What are the alternatives to an MBO?
If a management buyout is not possible, how else can a company change ownership? It depends on who you are – the owner wishing to exit, or the employees wishing to buy.
The owner wishing to exit
The owner of the business has a greater range of options to disburse their interest in the company than the employees. Although an MBO would seem the most likely candidate to secure succession, other options include:
- Trade sale: Direct sale to a third party, often a competing business operating in the same sector.
- Family transfer: A family member takes over the reins. This is a popular choice of succession with family-run businesses.
- External management introduction: Rather like bringing in a specialist to fix a problem, new management is hired to take over the day to day running of the business. The owner still retains ownership and ultimate control.
- Employee buyout: The business is sold to all the employees, not just the current management. Typically, this involves a co-operative arrangement for shared ownership.
- Stock market float: The business offers shares to buyers via an IPO. The owner sells their shares, and the stockholders appoint new management.
The employees wishing to buy
If an MBO is not feasible, the company employees could still purchase the business via an employee buyout. This form is succession involves all the company employees, not just the management team and they can own the business in various ways, either directly or indirectly.
- Indirect ownership: Employees set up a trust that holds shares on behalf of the employees. The trust might hold the shares forever, or distribute them to individual employees, or a combination of the two. It can also buy shares back from employees who want to sell (for example, when they retire).
- Direct ownership: Employees can also own shares in their own names. One option is for employees to acquire their shares over time. This could be as bonuses, or part of their remuneration. Alternatively, the shares could be purchased by an employee trust which later distributes them. Or some shares could be owned directly by individual employees, while an employee trust owns and keeps the rest. Additionally, the employees may choose to form a co-operative that then acquires the business. Putting shares into an employee trust can have significant tax advantages. Using a trust may also be a good way of raising bank finance to acquire the shares.
Should an MBO or an employee buyout not be possible, the management team could also consider a startup. This would be a completely new business, but it would have the benefit of the skills, ideas, contacts, and resources of a proven management team, which may make it easier to acquire startup capital in the form of investment, loans, or grants.
How do I apply for management buyout finance?
MBO, MBI, BIMBO, LBO, trade sale, spin-off, startup – there are many ways to start, buy, or sell a business. Register with Asgard today for confidential advice on the type of transaction that is best for you.