Succession planning: Funding a management buyout

Planning for succession is a really important aspect of ensuring a business’ longevity, and it shouldn’t be underestimated how long it can take to put an exit strategy into action. Ensuring a smooth transition will take many months and sometimes years of planning.

One of the main ways of exiting a business is through a management buyout (MBO). Essentially, this is where the senior management team steps forward to take on the business.Katherine Broadhurst, Partner, looks at why MBOs are often a great succession route to ensure a smooth transition and continued business success, and some of the ways in which an MBO can be funded.

Why an MBO?The best MBOs will have been considered carefully in advance and will have involved substantial planning, often meaning a gradual exposure of the management team to the day to day running of the business and strategic decisions over time. In some cases, new team members are brought in to strengthen the management team ahead of an MBO.An MBO can provide a vendor with a number of positive non-financial considerations compared with selling to an external buyer, including:

  • potentially better job security for the workforce
  • continuity for customers and suppliers
  • less disruption overall as the deal requirements are completed with full cooperation and understanding
  • a greater chance of success and legacy, as the management will already have an in-depth knowledge of the business, its products, services and markets
  • It is important with an MBO that preparation time is used positively, providing an opportunity for the advisors to work with the management team to ensure they clearly understand financial information, start to think strategically and line up any funding required for the final transaction.At Azets, we have seen significant MBO activity in recent years. Key reasons for this are the availability of debt funding and vendors being prepared to form part of that funding package themselves through deferred consideration.Management equityFinancing a buyout through management equity is a potential route but rare – it is a common misconception that the management team needs to fully fund an MBO by itself. Typically, those taking on the business will invest proportionately based on their proposed role and their own financial circumstances, in the knowledge that their personal contributions convince other lenders of a clear commitment to the long-term success of the business.Third-party lendingDeferred consideration is involved in the vast majority of MBOs and is effectively the vendor acting as a funder. Few transactions, whether third-party sales or MBOs, involve full consideration being paid immediately due to the significant sums of money involved, the challenges involved in raising funding and a wish to ensure the vendor is engaged in providing a smooth handover. Third-party lenders may require an element of deferred payment to ensure the vendor is also committed to the transition. High street banks and alternative lenders such as Shawbrook and Thincats have all been supportive of MBOs in recent years. Regionally there are funders with economic development motivations who also value MBOs and therefore have an appetite to provide funding.Whilst we are seeing some challenges in the funding market at the moment as a result of economic uncertainty, the non-financial considerations mentioned earlier in this article are often considered to lower the risk for funders, mitigating the impact on the ability to fund a transaction.Private equityMBO funding is also available through private equity firms with an investor acquiring shares in the business, often as a minority shareholder. The total finance is often split between debt and equity elements. The investor is paid interest on the debt element, potentially dividends as a result of the shareholding and will seek to support growth in the business to benefit from increasing capital value. In general, private investors support businesses where exit with a return can be achieved in a period of 3-5 years but potentially up to 7/8 years.Planning aheadMany MBOs still rely on traditional bank finance including loans for the transaction and invoice finance for working capital and the new management team will need a financial plan in place to demonstrate it can meet the bank’s repayment and security requirements. Furthermore, different funding options will have different tax implications and therefore getting appropriate advice on a coordinated basis is important.Whichever route is chosen, planning ahead is essential for a successful MBO; historic financial information and projections need to be robust, and the management team will need to demonstrate strong knowledge of the business and an ability to replace the vendors in all aspects of their roles. It can be an interesting time as the dynamics move between the parties as the transaction progresses. This is necessary to build the funder’s confidence and belief in the management team’s ability to successfully continue running the business.

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If you have any questions in relation to MBOs or would like to discuss your specific business’ circumstances and the potential options available to you as a business owner or manager, please get in touch with your usual Azets advisor or a member of our specialist team.

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