Management Buyout Finance (MBO)
In this article we deep dive into MBOs. What are they, how do they work and how can they be financed.
Author: Gary Hemming CeMAP CeFA CeRGI CSP
20+ years experience in business loans
Here we look at management buyouts – this is where an individual, or a group, from the management team at a company seeks to buy the business from the owner. Ownership of the business will then be legally transferred to the new management team.
In most cases the capital required to complete a management buy out will be a significant amount, which is raised through a business loan or a combination of funding sources.
It is recommended that specialist professional advice is sought for those seeking funding for a management buyout as this type of arrangement is often complex. ABC Finance can support you through the process with over twenty years of experience in business finance.
What is a management buyout?
Management buyouts are where the managing team in a company buys the operations and assets of a company and takes legal control of the business, becoming owners rather than employees. The new owners will also have responsibility for any debts or liabilities related to the company.
There are a number of reasons for management buy outs, a common reason is when the owners of a business wish to retire yet retain some connection to the business. They may relinquish ownership and still play a role within the company without being responsible for overall decisions.
In some cases a company may be struggling and the consortium seeking to buy the business will look to restore it to profitability.
Other reasons for MBOs are when a parent company wishes to divest itself of part of the business and focus on other areas.
How does a management buyout (MBO) work?
The existing management team within a company will seek to take legal control of a business, purchasing the company either partially, or in full from the owners. This makes the management team directors, rather than employees.
In a management buy out situation, the individual or group wishing to purchase the business will understand its operations and potential for profit very well as they have been working within the company. This can make for a smoother transition and in some cases a quicker sale although an MBO will take several months to complete and six months is realistic depending on the complexity of the purchase and the financial arrangements involved.
Even if the existing management team knows the business well they should still undertake careful research and due diligence as there may be areas of operations, legal or financial issues that they do not know about; for example, tax liabilities.
What is the difference between a leveraged buyout (LBO) and MBO?
A leveraged buyout (LBO) is when one company purchases another company and a loan is taken to raise funds to complete the purchase – effectively a leveraged buyout uses debt to fund the acquisition. The loan is then paid off using the cash flow and the assets of the business being acquired, and in some instances the assets of the company seeking to purchase the company will be used to secure finance.
What are the differences between MBIs, MBOs, and BIMBOs?
A management buy-in (MBI) is where a management team from another company seeks to purchase a business. The new team will replace the existing management team. This is in contrast to management buyout where an existing managerial team within a company seeks to take over ownership and operations.
Buy-in management buyouts (BIMBOs) is a type of leveraged buyout (LBO) and this is a combination of a management buyout and buy-in. A BIMBO is where an existing management team works alongside an incoming management team to form a new group intending to purchase a company.
How do I finance an MBO?
The capital required for an MBO is often considerable and can be raised through a variety of methods. It is likely that an MBO will be fully, or partially funded by a long term business loan.
Some of the key sources of funding are as follows:
Business loans: buyers will often require sizeable business loans, however, banks and traditional lenders can view MBOs as risky endeavours and so a specialist broker should be engaged to manage the financing aspect of the deal.
Private Equity: This is a type of alternative investment, however, firms that offer private equity may often loan money in return for a share of the company
Personal financing: The MBO team may use their own capital to either partially, or fully, fund the purchase of the company. Buy outs funded entirely by personal capital are rare and some form of financing is usually required. Often the management team will seek to raise funding through secured personal loans.
Secured loans: Secured loans are based on assets or ‘collateral’ so the lender will have confidence that monies can be recouped if the business defaults on payments. Often assets such as property are used as collateral to secure loans.
Interest rates on secured loans are ordinarily lower than unsecured loans as there is a guarantee that the lender will get their money back; however, with long term secured loans interest rates can be higher as the prospective lender will be tying up funds over a longer time frame.
How do I apply for management buyout finance?
Speak to an expert at ABC Finance if you are considering buying a business. Management buy outs can be complex with very many finance options available.
Understanding lender requirements is important and we are here to guide you through the process. MBOs can take several months, typically six to nine months, to complete and so it is essential to seek professional support before you begin the MBO
We take the time to understand you and your business. Get in touch for a free callback and introductory discussion.
Management buyouts – the tax implications
Management buy outs can have significant tax implications and it is essential to seek financial advice to understand the potential liabilities that come with buying a business, as this can be a complex area. Some of the main tax liabilities are:
Capital gains tax is a tax that is levied on the sale, or disposal, of assets that have increased in value. You will only pay tax on the profit made, not the overall money received. For example, if you bought a house for £500,000 and sold it for £600,000 you would be liable for tax on the profit, which in this case is £100,000.
Disposing of an asset includes selling it, giving it away as a gift, swapping it for something else of value or receiving compensation – such as an insurance payment if a valuable item has been lost or damaged.
Some assets are tax free, and you do not have to pay Capital Gains Tax if the gains are below your yearly tax-free allowance set by HMRC.
Corporation tax is based on the profit your company makes and in the UK the rate is 25% on all limited companies. There are over five million registered companies in the UK and those that are trading will need to pay corporation tax to His Majesty’s Revenue and Customs (HMRC). HMRC is the UK’s tax, payments and customs authority.
Inheritance tax is a tax on property, money and possessions that are passed on when someone has died, this is also referred to as someone’s estate. There is a threshold below which no tax is paid and this is £325,000 in the UK.
Business Relief of 50% or 100% can, however, reduce tax liabilities when any ownership or share of a business is passed on while the owner is still alive, or after their death. It is strongly recommended that financial advice is taken to understand potential tax positions.
Value added tax (VAT) businesses that earn over £90,000 must charge VAT at the rate specified by HMRC on their goods and services. Before acquiring a business the buyout team should have a clear picture of tax liabilities.
Stamp duty is a tax applied to the purchase of a business’s assets and shares and this will likely be a considerable cost to factor into any management buyout.
The MBO Process – How It Works
Before the MBO gets underway the potential new managerial team will have to prepare a thorough business plan, and select who will undertake key roles if the buyout is successful.
Detailed financial research must be undertaken to understand the profitability, or otherwise, of the business and any outstanding liabilities; for example, tax liabilities.
The company must then be valued independently and any potential finance arrangements will be based upon this valuation. The final valuation will need to be agreed on by all parties. The valuation will need to reflect the current state of the business and its assets, and also its potential profitability.
Once funding is provided and the sale is completed a new team will take control of the business. They will then be responsible for repaying finance, any tax or legal liabilities and need to comply with UK laws and regulations.
Once a valuation has been agreed a ‘special purpose vehicle’ (SVP) will be created and this is a holding company that manages financial and legal arrangements during the acquisition.
Finance will then be agreed and it is important to have funds in excess of those required for the purchase and to ensure that there is adequate cash flow to keep operations going.
Methods of funding must be investigated carefully. Banks are often unwilling to finance MBOs in full as they view them as risky. A combination of financial instruments, or products may be required and specialist advice should be taken.
The final stage is acquisition where contracts are agreed and signed and the legal transfer takes place. The business will now be under new ownership with new directors who are legally responsible for operations.
MBOs and Multiple Level Financing
Owing to the large amount of funding typically required in an MBO situation, there may be several forms of funding involved.
Often there will be a main business loan that will cover purchase, and initial cash flow requirements; however, the potential new directors may be required to put up personal collateral to fund debt. This may be used in addition to loans secured against assets such as property, equipment or in some situations merchandise if it is of significant value.
A specialist broker is key to finding the right lenders. Speak to our team at ABC, with twenty years of experience in MBOs so we can save you money and time.
We take the time to understand you and your business. Get in touch for a free callback and introductory discussion
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