4 Key Strategies for Financing a Management Buyout

A management buyout is a form of business acquisition, where managers buy a company from its existing owners. Even though an MBO is usually linked to well-established, larger companies, it can also be applied to small businesses.

There is a wide range of management buyouts, most popular of which is a so-called leveraged buyout (LBO). It can be defined as a way of purchasing a company by using the money that is borrowed from a third-party. In other words, managers usually don’t have enough personal funds needed to meet the cost of acquisition and that’s why they turn to external financing. Now, there are numerous financing options management teams use to make the process of transaction go smoothly.

Let’s take a look at some of them.


Senior Debt


Other than the money borrowed from friends and family, senior debt is probably the most reliable funding solution. Providing you with a wide range of options (it can be short- or long-term, as well as secured or unsecured), it is considered highly flexible. The way it works is pretty simple. While the investors don’t have any share in the company ownership, they receive interest at an agreed rate. And, if the conditions aren’t met and they aren’t paid their money on time, they are entitled to take control of particular assets owned by a company.

Now, senior debt is a pretty complex notion, consisting of various types of financing, most popular of which are bank loans. However, you need to know that getting a conventional loan is a tedious task. Namely, banks see management buyouts as too speculative and that’s why they aren’t usually willing to take a risk. To be eligible for a loan, you need to have substantial personal wealth, put up these personal assets as collateral, and have a good personal credit history. Additionally, to make sure that it will meet all your needs, you should consider getting a bank loan that is guaranteed by the Small Business Administration.


Private Equity


As you can see from the previous examples, the likelihood is that a bank will turn down the buyers’ application. In this case, most of them resort to equity funding as one of the most effective and reliable MBO financing solutions. Namely, the private equity company invests in a company buyout in return for the company’s shares. Furthermore, these investors also provide the managers with some additional funding options, such as loans or asset-based financing.  

Now, private equity is closely related to personal financing, discussed below. Namely, to ensure that the management believes in the buyout and the future company’s growth, private equity companies require that they contribute invest their personal funds.

Also, you need to know that private equity backer may sometimes have utterly different goals from you. For example, they want to boost their ROI and make an exit after 3-6 years, minimizing risks. Additionally, they may also impose numerous conditions regarding the business’ growth. Namely, their aim is to make sure that the company will stay profitable during the term of their investment. This may make new owners feel restricted, given the fact that they usually start with looking at the big picture and basing their company on solid, long-term objectives.

But, as a proverb says, where there’s a will, there’s a way. You just need to do a thorough research and choose a private equity company whose goals are aligned with yours.


Contributing your Personal Wealth


Probably the most notable form of financing comes from the managers planning a buyout. Namely, each member of a management team needs to invest some of their personal money and assets to buy a target company. This sum doesn’t have to be vast, but it usually represents roughly 6 to 12 months’ salary. Moreover, it is not unusual for managers to raise the money needed by selling off their private assets or even getting a second mortgage on their houses.

What you need to keep in mind is that the management team’s contributions are immensely important. By investing your personal wealth, which can sometimes be extremely risky, you are actually justifying your actions and show how committed you are to the company. Most importantly, by taking a risk, you will prove to both sellers and lenders that you believe in the business’ values and its success in the years to come.


Contributions Made by Sellers


One of the most common ways to finance a management buyout is seller financing, also called a deferred consideration. Namely, the seller provides the buyers with a loan that is amortized for some time. Once your revenue starts growing, you pay the loan back.

But why do managers turn to this option?

For starters, as a condition of financing the acquisition, some lenders might require the sellers to contribute to funding a management buyout. This condition is some sort of a guarantee for them, meaning that the seller believes that the business will remain profitable in the future.

Also, it’s is one of the most flexible MBO financing solutions. Unlike banks, sellers are usually more willing to provide the management team with the adequate funding. The finance about 30% to 60% of the sale price, and just few sellers agree to finance more than that. However, a seller will give you the cash needed only if they believe that you are a good fit for a company. That is exactly why they will want to take a closer look at your credit history, assets, business plan, and management experience.

To Wrap it Up

A management buyout is usually a result of an agreement between company owners, managers, and lenders. If it is done properly, all parties may benefit from it. All you need to do is conduct a detailed research, understand the basic principles of a management buyout, and choose the most viable options to finance it. Hopefully, the techniques listed above will help you do so.

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