Management buyouts: A detailed overview

9 mins

Posted on 09 Oct 2023

Management buyouts: A detailed overview

A management buy-out (MBO) is one of many options available for business owners who are looking for a suitable exit strategy. This is a strategic transaction which allows a company’s existing management team to acquire ownership of the business they are currently operating.

How Do MBOs Work?

This strategy requires careful planning and execution, as the process can be complex, involving several key stages:

  1. Preliminary assessment and planning

    The management team evaluates the feasibility of the MBO, considering factors such as the company's financial health, market conditions, and their ability to secure financing. Detailed planning is then required, including structuring the deal, identifying potential sources of funding, and setting objectives for the transaction.
  2. Identifying sources of financing

    There are various financing options available, including:

    Equity investment

    The management team may contribute their own capital to the transaction, which demonstrates their commitment to the business.

    Debt financing

    To fund the purchase, the management team can seek loads from banks, financial institutions, or other lenders.

    Seller financing

    The current owner or seller may provide financing to facilitate the transaction, either as a loan or as deferred payments.

  3. Due diligence

    A comprehensive legal review is conducted to identify any legal issues, contractual obligations, or potential liabilities associated with the business. Financial statement, tax records, and other financial documents are also reviewed to assess the company's financial health and performance. 

    Dependent on the finance arrangements for the MBO, due diligence is usually less detailed and comprehensive because the management team already know most of the critical information relating thereto. This can make the process much quicker and cheaper to complete than a trade sale to an external buyer.
  4.  Negotiating terms

    The management team and the seller negotiate the terms of the purchase agreement, including the purchase price, payment schedule, and warranties. If external financing is involved, negotiations with lenders or investors occur to secure favourable terms.

    Again, because the management team are already involved in the business, it is often much easier to agree terms.
  5. Financing and closing

    Once financing is secured, the management team proceeds with the purchase of the business, and the deal is closed.
  6. Post-transaction operation

    The management team assumes full ownership and operational control of the business. They are responsible and managing and growing the business to achieve their strategic objectives.

    Sometimes the sellers will continue to be involved in the business for a handover period, especially if they have provided Seller finance in the form of loans or deferred consideration.

What is Seller Financing?

Seller financing, also known as vendor financing or owner financing, is a financing arrangement in which the seller of a business provides a loan to the buyer (in this case, the management team) to help facilitate the purchase of the business.

Instead of the management team securing a loan from a third-party lender, they receive the necessary funds directly from the seller.

How does Seller Financing Work in MBOs?

Seller financing in MBOs typically involves the following key components:

  1. Loan terms and agreement

    The seller and the management team agree on the principal amount of the loan, which represents the purchase price of the business. The parties then negotiate an interest rate, which is the cost of borrowing the funds. This rate can be competitive and mutually beneficial.

    A loan agreement is then put in place, outlining the repayment schedule, including the frequency of payments (e.g., monthly, quarterly) and the duration of the loan.
  2. Security

    To secure the loan, the seller may take a security interest in the assets of the business being sold as well as over the shares being transferred. This provides the seller with collateral in case the management team defaults on the loan. 
  3. Transition and ownership

    Upon completion of the MBO transaction, the ownership of the business is transferred to the management team, and they assume full control of its operations. The management team is responsible for running the business and generating the cash flow necessary to make loan payments to the seller.
  4. Benefits for sellers

    Sellers receive a stream of income from the loan payments, providing them with a reliable source of cash flow, even after the sale of the business.

    Seller financing can also offer flexibility in negotiating the terms of the loan, potentially resulting in favourable interest rates and repayment schedules. It can also allow a transaction to proceed where other external and traditional finance arrangements are not available.
  5. Benefits for the management team

    Management teams may find it easier to secure financing from the seller, as the seller has firsthand knowledge of the business and may be more willing to provide funding. Seller financing can also facilitate a smooth transition, as the management team is already familiar with the business and its operations.

What is Debt Financing?

Debt financing, also known as leverage or borrowing, is a process in which a business raises capital by taking on debt. This debt can come in the form of loans from banks, financial institutions, or private lenders, which must be repaid with interest over time.

In the context of an MBO, debt financing helps the management team acquire the business by providing the necessary funds for the purchase.

How Does Debt Financing Work in MBOs?

Debt financing in MBOs typically involves the following key steps:

  1. Determining capital needs

    Before embarking on an MDO, the management team and their advisers assess the capital requirements for the transaction. This includes estimating the purchase price of the business and any additional funds needed for working capital, improvements, or restructuring. 
  2. Identifying lenders

    The management team works with financial advisers and lenders to identify potential sources of debt financing. This may include:

    Traditional banks

    These financial institutions offer various loan products.

    Private equity firms

    Some private equity firms specialise in providing debt financing for MBOs.

    Mezzanine financing providers

    Mezzanine financing combines debt and equity elements, and can be useful for bridging funding gaps in MBOs. 

    Alternative lenders

    Non-traditional lenders, such as asset-based lenders or peer-to-peer lending platforms, may also be considered but are generally seen as an expensive alternative.

  3. Structuring the debt

    Once the lenders are identified, the management team, with the assistance of financial advisers, structures the debt financing. This involves determining:

    Loan amount

    The total amount of debt required to complete the MBO.

    Interest rates

    The interest rates associated with the loans, which can be fixed or variable.

    Repayment terms

    The schedule for repaying the debt, including the frequency of payments (e.g., monthly, quarterly) and the maturity date.  


    Any assets or guarantees provided as security for the loans.                                

    Obviously, it is important for both the lender and the management team to establish that the debt finance can be repaid from free cash generated by the business.
  4. Loan application and due diligence

    The management team submits loan applications to the selected lenders. Lenders conduct due diligence, which includes a review of the business' financial health, the management team's qualifications, and the proposed MBO structure.

    Clearly, where there are external funders involved, the due diligence required is much more involved than where finance is provided solely by the seller who already knows the business and the management team.
  5. Loan approval and completion

    Upon approval of the loans, the management team and the sellers proceed with the MBO transaction. The debt financing is used to fund the purchase of the business, and the ownership is transferred to the management team.
  6. Post-completion operations

    After the MBO is completed, the management team is responsible for operating the business and repaying the debt according to the agreed-upon terms. Successful operations are essential to ensure timely debt repayment and the financial health of the business.

Advantages of Debt Financing in MBOs

Debt financing allows the management team to acquire the business while preserving their ownership stake. They retain a larger share of the business's equity compared to using only equity financing. It can also enhance the management team's purchasing power and provide access to larger and more lucrative opportunities.

Considerations for Debt Financing

Managing debt comes with financial risks, including the obligation to make regular interest and principal payments. It's crucial to have a solid financial plan and revenue projections, to ensure the business can service the debt.

Building strong relationships with lenders is also essential. Clear communication and meeting repayment obligations are crucial to maintaining lender trust.

Finally, a robust balance sheet and cash flow are vital for securing favourable debt terms and maintaining financial stability post-MBO.

Debt financing can be a powerful tool in enabling MBOs by providing the necessary capital to acquire a business. However, it requires careful planning, due diligence, and risk management to ensure a successful transition and long-term business success.

Advantages and Disadvantages of MBOs

Advantages of an MBO for Sellers

Legacy preservation

MBOs often allow business owners to preserve the legacy they've built over years by passing it onto a trusted management team.

Control over the process

Sellers have more control over the terms and conditions of the sale, including the choice of the management team.

Potential for ongoing involvement

Sellers can choose to stay involved in an advisory capacity or as a minority shareholder, maintaining a stake in the company's success.

Disadvantages of an MBO for Sellers

Risk to payment

Seller financing carries the risk that the management team may default on payments, which can impact the seller's financial security. 

Potential for conflicts

The transition process may lead to conflicts of interest or differences in management style, requiring careful negotiation and conflict resolution. 

Key Considerations for MBOs

Securing the necessary funding is crucial for a successful MBO, and careful financial planning is essential. Thorough due diligence is also required to uncover any potential risks or liabilities associated with the business, and the legal and tax implications must be considered. Advisers will play a vital role in structuring the MBO, aiming to ensure that all benefits are maximised whilst also minimising risks, but it is critical that the management team’s qualifications, and their ability to lead the business, are at an appropriate level in order for the MBO to succeed.

Contact Doyle Clayton

If you’re considering a MBO as an exit strategy, or simply require further information, you can book a meeting directly with one of our team, via this link. Alternatively you can contact the team via email.

Thomas Clark

Thomas is an experienced corporate lawyer who advises clients on matters including business sales and purchases, shareholder agreements and articles of association, reorganisations, preparation for sale, and employee incentives.

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The articles published on this website, current at the date of publication, are for reference purposes only. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your own circumstances should always be sought separately before taking any action.

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