How to fund Management Buyouts (MBO’s) with insufficient personal cash
An MBO occurs when a company’s existing management team purchases the business from its current owners. This process often happens in situations such as retirement of the current owner or corporate restructuring. MBOs are popular in the construction industry as they can ensure continuity of the business as the management team is already familiar with its operations, culture, and strategic direction.
However, a major hurdle is often the lack of sufficient personal cash among the management team. When a company wants to support its management team in funding an MBO there are several options available. Cash flow in the construction sector can be poor, with funds tied up in working capital, but this shouldn’t mean that an MBO isn’t feasible, despite the cash flow challenges.
This insight covers key financial approaches and options for both buyers (management) and sellers (current owners).
From the buyer’s perspective
Deferred consideration
Deferred consideration involves agreeing to pay a portion of the purchase price over time based on the company’s future performance. This can be structured as earn-outs or instalment payments. It aligns the interests of both buyers and sellers, as the final purchase price is contingent on the business achieving specified financial targets. This approach reduces the need for immediate cash.
Vendor financing
Another viable option is vendor financing, where the current owner agrees to finance part of the purchase price. This arrangement is beneficial for both parties; the seller can negotiate favourable terms and potentially gain a higher price for the business, while the buyers can reduce the immediate cash outlay. The management team can structure the repayments based on the company’s earnings, ensuring manageable debt service.
Loan financing
The management team borrow funds, secured against the company’s assets, to finance the purchase. Construction companies often have valuable assets like equipment, vehicles, and real estate. These can be used as collateral to secure loans from banks or specialised lenders. The debt is repaid using the company’s future earnings. It is advisable to conduct a thorough cash flow analysis and stress-test the debt repayment plan to ensure the company can service the debt without jeopardising its operations. This approach is viable if the company has stable and predictable cash flows.
Equity financing
Management can also consider equity financing by bringing in third party firms or individual investors who are willing to invest in the buyout. These investors often bring valuable expertise and strategic guidance, which can be advantageous for the company’s growth post-buyout. While this means sharing ownership, it can provide the necessary capital without incurring heavy debt.
Utilising personal assets
Leveraging personal assets, such as property or savings, can help cover part of the buyout costs. Personal loans or credit facilities are also viable. Banks may offer favourable terms if there is a robust business plan and performance track record. It’s crucial to evaluate the risk to ensure personal finances are not overly exposed.
From the seller’s perspective
Flexible financing options
Sellers can enhance the buyout’s feasibility by offering flexible financing, such as vendor financing or deferred payments. Alternatively, the seller can approve for remuneration of the management team to be flexed either up or down to give a preferred outcome. Increased remuneration via a bonus can provide the management team with cash to fund the MBO, versus decreased remuneration to improve the working capital of the company which provides additional cashflow within the business. This flexibility can help bridge the gap between the buyer’s available cash and the business’s valuation, making the transaction more achievable for the management team.
Valuation
Construction companies often possess specialised knowledge and techniques, as well as long standing client relationships, which can be retained within the business if the valuation and finance in place allows the management to retain the business going forward. Ensuring a fair valuation is critical. Overvaluing the business can make the buyout unaffordable, while undervaluing it can lead to financial loss for the seller. Engaging professional valuers to conduct a thorough business valuation is essential.
Retaining a minority stake
To facilitate the buyout, sellers might consider retaining a minority stake in the company. This can reduce the upfront cost for the management team while allowing the seller to benefit from future growth. It also demonstrates confidence in the business’s continued success under new management. Unlike external acquisitions, an MBO usually results in minimal disruption to day-to-day operations. This stability is crucial in the construction industry, where project timelines and client expectations are paramount. This option aligns the interests of both buyers and sellers to maximise future wealth.
Utilising external advisors
Sellers can benefit from utilising external advisors to structure the deal in a way that maximizes tax efficiency and minimises risk. Advisors can also help in negotiating terms that are fair and beneficial for both parties, ensuring a smoother and more successful buyout process.
Conclusion
Funding an MBO is challenging but achievable with the right strategies. By combining several of these financing methods, management can structure a robust financial package to facilitate the MBO, even with limited initial cash. The key is to build a compelling case for the investment, demonstrating the management team’s ability to lead the company successfully post-acquisition. Moore Kingston Smith LLP can assist with the necessary preparation for an MBO, including reviewing business plans, valuations, structuring the deal and guiding you through the process to ensure a smooth handover. If you’d like to discuss, get in touch with our construction specialists.
