How is a management buyout funded?
Management contribution, bank debt, asset based lending and vendor loan notes. What each one costs, and why the seller usually funds part of their own exit.
Management teams rarely have the money. That is the defining constraint of a management buyout, and everything about how these deals are structured follows from it.
The price gets assembled from four sources, and the mix decides how much you get on completion and how long you wait for the rest.
Where a £5m MBO price comes from
Illustrative only, using round numbers. Every deal is funded differently.
1. The management team’s own money
Lenders want to see it. A team with nothing at risk is a team that can walk away, and no bank funds a buyout on that basis.
In practice this often means remortgaging. Something in the region of five to fifteen per cent of the price between the team is a common expectation, though it varies with deal size and with what the business can carry.
It is worth being alert to what you are asking of people here. A manager on a good salary putting their house behind a buyout is taking a risk of a completely different order to the one they took by working for you.
2. Bank debt
Usually the largest external piece. Serviced out of the company’s own cash flow, which means the business is paying for its own purchase.
What lenders look at: consistent profitability over three years, the strength of the team taking over, customer concentration, and whether earnings are contracted or won again every year. Terms of three to five years are typical, with covenants attached.
The constraint is affordability. Debt service comes out of the same profit that funds your loan note, so more borrowing at completion generally means a longer wait for the balance.
3. Asset based lending
Where there are assets to lend against: debtors, stock, plant, property. It can sit alongside bank debt and lift the total available, and it is particularly useful in businesses with a large debtor book.
It is more expensive than senior debt and it brings ongoing reporting obligations. It is also the piece that makes a deal possible in sectors where earnings alone would not support enough borrowing.
4. Vendor loan notes, which means you
The part of the price you leave outstanding, paid from future profits over an agreed period. Three to five years is common.
On many MBOs this is thirty to forty per cent of the total. You are, in effect, lending the management team the money to buy your business from you.
Terms worth negotiating hard, before heads of terms rather than after:
- Interest. You are taking risk and waiting. That should be paid for
- Security. You will rank behind the bank, but a second charge is better than nothing
- Repayment schedule. Fixed instalments give certainty, profit linked payments give flexibility to them
- Acceleration. What happens on a sale of the company, a change of control or a default
- Information rights. You should see the management accounts while you are still owed money
- What happens if they miss. Agreed before completion, not improvised afterwards
Private equity backing
Where the team is strong and the business is large enough, a fund can back the buyout. That usually means more cash on completion for you, and for the team it means a partner with a view on how the business is run and an expectation of a further exit in three to five years.
For the seller it is often the better outcome financially. For the team it changes what they are buying: not independence, but a board.
Testing whether it can be funded
Before any conversation with the team, the arithmetic has to work. Take sustainable adjusted earnings, work out what a lender would advance against them, add anything asset based lending could support, add what the team can realistically raise, and see what gap is left. That gap is your loan note.
If the gap is most of the price, the deal is not fundable at that value. Better to discover that on a spreadsheet than in a conversation you cannot take back.
The adjusted EBITDA calculator gives you the earnings figure lenders will start from, and the valuation calculator a range to test it against.
How we approach it
We model the funding before anyone speaks to the team, because an unfundable MBO damages a business and cannot be undone. We work alongside a legal practice and an accountancy firm so the structure, the loan note terms and the tax position are handled together. More on the route generally on the management buyout overview.
Answered.
How much does the management team need to put in?
Typically five to fifteen per cent of the price between them, though it varies. Lenders want personal commitment rather than a specific number, and a team with nothing at risk will struggle to raise anything.
What is a vendor loan note?
Part of the price left outstanding, owed to you by the buyer and repaid from future profits over an agreed period, usually three to five years. It often makes up thirty to forty per cent of an MBO price, and you generally rank behind the bank.
Can the business borrow to buy itself?
Effectively yes. Bank debt raised for the buyout is serviced out of the company’s cash flow, so the business funds its own purchase over time. The limit is what those earnings can comfortably support alongside everything else.
What if the team cannot raise enough?
Then the price comes down, the loan note goes up, private equity comes in, or the deal does not happen. Finding out which before you raise it with the team is the whole point of modelling it first.
Can the team actually fund it?
An unfundable MBO conversation cannot be taken back. Work out the answer on paper first.
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