If you are an owner looking to sell your business or a senior employee thinking of buying the company you work for, you’ll already be familiar with the term MBO, which involves the management team pooling resources to acquire all or part of the business they manage. Commonly, the management team will use company assets as collateral to secure external finance. However, in the absence of an asset-rich balance sheet, financiers may still be keen to support the transaction if projected cash generation is strong and a credible management team is in place.
For a business undergoing a change in ownership, the MBO offers advantages to all concerned. Most obviously, it allows for a smooth transition. Since the new owners know the company and its business, potentially there is a reduced risk, other employees are less likely to be apprehensive and existing clients & business partners are often reassured. Furthermore, the internal process and transfer of responsibilities remain confidential and are often handled quickly. Going forward, the management team can use its experience and knowledge already in place to grow the business.
The buy-out team will need to develop a strong business plan to prepare for the acquisition. The financial forecast should be credible and realistically attainable. Buyers will need to ensure that the venture is suitably profitable keeping in mind that the MBO may require substantial financing which will have an impact on company cash flow. If the seller accepts to defer an element of consideration for the sale of his or her shares, they also need to be confident in the achievability of the projections and have a full understanding of all risks involved.
Financing an MBO
A MBO acquisition is typically funded through a mix of sources, including the management team, external financiers and potentially, the seller.
Personal funds can help secure confidence from a financial institution, add equity to the transaction and share risk. The investment of personal funds by the management team helps demonstrate a commitment to the company and its future prosperity.
External finance by way of cash flow loans, invoice discounting, mortgage, private equity or other financial products are commonplace when financing a MBO transaction. Depending upon the business’ current debt obligations and track record, access to this funding may be relatively straightforward and deliver substantial finance. That said, financiers may perceive an increased risk with a MBO transaction which may decrease accessibility of such funding compared to what that current owners may be able to obtain, reduced repayment terms and increased costs by way of extra due diligence and higher interest charges. The financier’s view of the management team’s credibility will be enhanced if consideration has been taken as to the implications of the extra costs and repayment of debt when preparing profit and cash flow projections.
It is often the easier option to remain with the company’s incumbent bankers when undertaking a MBO as they will already know the business, but financiers’ appetites for the risks associated with backing MBO transactions may fluctuate substantially. By reviewing alternative funding models and speaking to a number of funders about what they are able to offer, advisers will be able to guide the team through the MBO process.
Seller financing comes as a result of the seller deferring consideration for their shares, either on a contingent or non-contingent basis. This will reduce cash outflow at the time of the transaction and make the transaction easier. Furthermore, it demonstrates the seller’s confidence in the management team’s ability to achieve projected results and may result in obtaining extra external finance.View all insights