If you’re considering a management buyout (MBO), the associated types of finance can be complex. Rather than just looking at the various business loans available, there are a few other products worth exploring which are designed with MBOs in mind. Here are a few things to think about if you’re considering an MBO.

MBOs vs MBIs

First of all, let’s clarify some of the terminology here. When we talk about MBOs, we’re referring to when an internal party takes over the company by buying out the current owners. This person, or group of people, could be the current managers such as C-level executives (with or without an existing stake), inactive shareholders like non-executive directors, or even current employees of the company.

What they have in common is they’re all internal parties on the inside of the business already. Management buy-ins (MBIs), on the other hand, are typically larger companies purchasing smaller ones via mergers and acquisitions — external parties becoming involved in the business for the first time. In this article I’m talking about the former.

In it for the long run

Whether you’re a current manager, a non-exec director, or a senior employee, if you’re looking to take over the company, lenders will want to see that you’ve had experience within the business already and are committed to its future.

From their perspective, although the existing business under current management has a track record, the proposed ‘new’ business under your management is something of an unknown quantity — therefore, any funding is heavily focused on the individuals involved in taking the business forward.

The reason for the MBO

The first steps potential lenders will take to understand your MBO is to try to understand the reasons behind it. There are many things that might prompt you to consider an MBO, and each of them will have a different appeal to the lender.

One common reason might be the current owner(s) retiring, so the other parties involved want to buy them out and continue on the same path. Another could be a large company splitting into smaller components, for example where regional managers take over their own ‘unit’ of the larger firm.

Finally, it might be a turnaround or rescue scenario, where the potential new owners propose a radical new strategy to take the business back from the brink, or the ‘phoenix’ scenario where a new business emerges from the ashes of the old one.

All of these scenarios mean that MBO finance is a bit different to typical business funding.

Term loans

The first route to financing your MBO is via a business loan — over a fixed term with fixed repayments. Lenders will take into account the business’s current performance and its projected future performance to determine affordability.

Because the latter is uncertain, for this route your personal situation is very important. Lenders will look into your personal credit file and net worth, how much money you’re willing to personally commit to the project, and what level of involvement you’ve had thus far — and if you’re currently a shareholder in a senior management position, your chances of getting this type of funding will be significantly better.

The strongest cases may be able to raise upwards of £500,000 unsecured, and this will almost certainly require personal guarantees from each person involved, as well as a personal investment in the company. If you want to raise more than this, or your current involvement isn’t sufficient to satisfy the lender, you’ll need to look into the secured route.

Secured loans and asset-based lending

We’ve established that funding for MBOs pays close attention to both the business and individuals involved — so for secured types of finance, the assets used might be business-related, personal, or both.

Asset-based lending is a type of finance that uses the bigger picture of the company’s balance sheet to determine funding, taking a combination of commercial property, plant and machinery, and the debtor book as security. Using this type of funding for an MBO is sometimes called a ‘leveraged buy-out’, because the assets of the business being purchased are leveraged to raise sufficient cash.

In some cases, the lender may also want to take the buyers’ personal assets as security. The common example would be a homeowner who can use the equity in their residential property, although lenders may also consider other categories of net worth including pension pots.

If you invoice your customers and they pay you on credit terms, the sales ledger may be sufficient security on its own — this could be thought of as asset-based lending too.

Mezzanine finance

Mezzanine finance gets its name because it is a combination of debt and equity. By combining the two types of funding, lenders get assurance that they’ll recover their costs as well as the potential benefits of an increase in value of their share of the business. Mezzanine finance is a commonly used way of funding MBOs when private equity firms get involved instead of commercial lenders.

Conclusion

MBO funding is inherently more complex that standard commercial lending. Where normal business loans are a fairly simple calculation of past business performance and future affordability, MBOs are much more difficult to underwrite because of their uncertainty.

For this reason, lenders will look at the people involved carefully, and take a wider variety of business and personal assets as security. With the mezzanine route, they can also use future equity as a form of collateral (although they wouldn’t use that term themselves).

Overall, if you’re considering an MBO, funding it will require a credible plan from currently-involved managers, significant personal commitments like personal guarantees and investments, and a wide range of business assets to use as security. For these kinds of complexities, whole-of-market intermediaries can be a big help in getting the wheels turning on the deal.

Case study: CRM agency Armadillo underwent an MBO in February 2018. Here, the company’s CFO Andy Brown discusses how the transaction came about and its impact on the business. 

Armadillo was founded in 1992. As a CRM agency, it’s been responsible for introducing pioneering CRM schemes to brands and currently works with major names such as McDonalds, The Walt Disney Company, Babyliss and hotels.com.

The founding directors successfully led and built the company for over two decades, but in the 2010s they took the decision to increasingly step back from the day-to-day running of the business. They promoted former client services director James Ray internally to managing director to manage the business ongoing.

At the same time they also brought in a non-executive director in Chris Thurling, and a part-time financial director (myself), to assist the Board with the ongoing governance of the business.

James, Chris and Andy quickly realised they complemented one another well as a team, and increasingly wanted to invest, or re-invest in certain areas of the business where they could see opportunities.

With the founders owning the vast majority of the business, it was becoming more and more difficult to achieve complete unity across decisionmaking, with some of these parties wanting short-term gains, others longer term. This, coupled with the founders not having a day-to-day role in the business, means they were much less able to influence their own wealth creation, and were very much reliant on others.

“The transaction has been a success for all parties, with the founders realising a significant return”

More often than not, the details of an MBO contractual agreement are confidential and neither party should disclose them. However, I can confirm that the MBO did not require third party inward investment, which was important to us and something we had wanted to, and still want to, protect.

If we could avoid it, we didn’t want to be subject to the demands and influences of private equity, investors or venture capitalists. The MBO attracted not insignificant legal and professional fees for both parties, and we worked with the company’s bankers who provided their support in the short term to facilitate the deal.

We are less than three weeks away from the official anniversary of the deal completing (22 Sept 2017), although we announced it further down the line, and we have had a profitable and successful year, including an office relocation from Bath to Bristol, investment in new senior staff roles, and more new customers starting to work with us.

I believe the transaction has been a success for all parties, with the founders realising a significant return for their asset (that they had carefully grown over many years), and the new owners having more control and ability to make decisions more quickly and unencumbered. We have absolutely no regrets and are very positive about the future of the company.