4 vital steps to finance a management buy-out

If you’re planning a management buy-out you need to consider every option to finance it says finance specialist Mike Nolan

The management buy-out (MBO) is typically viewed as a process more aligned with larger organisations.

However, there are a number of situations in which an MBO might be appropriate for small businesses too – for example, where there is a disagreement among senior management or a partner is keen to step away from the company.

In such cases, there are a number of important considerations for ensuring a potentially complex process runs as smoothly as possible, not least of all deciding which method of finance is most appropriate.

Despite the banks' crackdown on lending to business there are a number of avenues available for funding an MBO, whether equity, debt or vendor assisted. In particular, both invoice and asset finance provide suitable options for releasing cash based on the strengths of the business and its future potential.

Is the management team ready to start the process?

Of course, before embarking on an MBO, it is essential to put a solid and viable framework in place to ensure the organisation is well-placed to succeed in the aftermath.

Motivated and committed leadership possessing a strong blend of skills and experience is vital. A management structure must be developed and a shareholders' agreement put in place, if necessary, to outline the division of leadership, while making provision for eventualities such as retirement, illness or death.

Lenders will examine such elements when making a decision on whether to provide finance but, more importantly, will scrutinise the future profitability of the business.

A business with a strong track record and solid forecasts might appear to be the safest bet but may also face significant challenges ahead. Equally, a business that has struggled to make a profit might harbour serious potential.

The onus is on management to develop a well-defined business plan that highlights a clear way forward, giving lenders the confidence that it represents a sound investment.

Could your invoices help finance your management buy-out?

When it comes to raising the required finance, a number of options exist. For example, the management themselves might be asked to contribute equity to the deal, although this includes a high level of personal risk.

Alternatively, they might turn to a business angel or venture capital fund to contribute but both of these options require surrendering equity – usually a sizeable chunk in the case of the latter.

However, if the organisation subject to the buy-out can demonstrate solid guaranteed revenues, invoice finance represents a sound option for borrowing against future income. In this situation, the financier will lend money against unpaid invoices as an agreed percentage of the total value.

This can be particularly appropriate given many MBOs will include a deferred consideration, where the vendor agrees the purchaser can pay some or all of the consideration monies for the business from cash generated at a later date.

The balance of the consideration can either be paid in one lump sum or in stages but takes pressure off the buyer to raise cash up front. This means they have the flexibility to assess the money coming into the business and anticipate periods of increased revenue, perhaps with the intention of borrowing against a significant invoice expected in the future.

Can you borrow against your business’ assets?

Invoice financing might not always be an option, however, particularly when the organisation subject to the MBO is a cash business.

When this is the case, asset finance provides an alternative where money can be borrowed against hard assets, such as property or existing equipment. A financier's willingness to lend will depend entirely on their perception of whether the debt can be serviced adequately, meaning businesses that have previously struggled can access funds if they are able to demonstrate a convincing business plan.

An adviser will be able to take a look at the assets in question and identify how best the money can be raised. Unlike a bank loan, this can often be achieved without the need for any securities but, in certain situations, a charge against the property may be required.

Have you got enough working capital to grow?

Surprisingly, when finalising an MBO, the one thing many buyers neglect is the necessity to plan for sufficient working capital on top of the funds required to complete the transaction.

It may be possible to complete the transaction only for the purchase to prove unviable as the extra funding needed would place too great a strain on the buyer and the business. Therefore, planning must account for the cost of a rebrand or reorganisation of the business or simply the ongoing investment required to ensure smooth running.

Lenders will usually only allow one opportunity to apply for funding so it is absolutely vital to get the sums right first time round. But if that one shot is planned and executed correctly, there is every chance the MBO will be a success.

Mike Nolan is managing director at asset finance specialist Academy Leasing


(will not be published)