Hardheaded approach pays dividends when funding MBOs

Access to a broad range of funding options when planning an MBO will avoid excess leverage, writes Frank Dillon

The importance of sufficient planning for the funding of an MBO cannot be underestimated.

Management buyouts (MBOs) are an attractive way for owners to cash out of a business, especially where they have grown an experienced management team that is capable of taking the company to the next stage of its development.

These deals often take place where there isn’t an obvious trade buyer for the company and there is a strong management team in place who understand the business and are prepared to invest in it. Owners may also have invested themselves very personally, as well as financially, in their businesses and are more comfortable selling their prized possession to people they know.

Sentiment aside, however, hardheaded decisions need to be taken both by vendors and those looking to lead an MBO, especially when it comes to financing the transaction.

In the current environment of elevated global geopolitical uncertainty, the importance of sufficient planning for the funding of an MBO cannot be underestimated, says David Martin, capital and debt advisory partner at EY Ireland.

David Martin, capital and debt advisory partner, EY Ireland.

“The starting point of any MBO transaction involves direct engagement with your adviser to define the business valuation, sharpen financial projections and establish funding requirements, both on day one and post the MBO. Shifts in the global economic landscape are leading to capital providers being more selective in the businesses they back, therefore, presenting your plan early to a capital provider will allow you to align decision-making timelines with lenders and private equity. Careful planning prior to entering an MBO process will help ensure you have an appropriate capital structure that mitigates against putting the balance sheet, and ultimately the business, at risk,” he says.

Funding dynamics for MBOs in the Irish market are continuing to evolve, he says, but the current geopolitical climate, combined with fluctuating interest rates in recent years, means it is important to maintain a broad range of funding options when planning an MBO. On a positive note, there is a wide range of options now for the right projects, he says.

“The capital markets in Ireland are made up of numerous Irish and European lenders and private-equity institutions. Having access to varied streams of capital, including third-party equity as well as debt, allows management teams achieve a more balanced capital stack and avoid excessive leverage. The availability of capital and the diversification of the funding landscape is also keeping funding terms competitive, reflecting a growing confidence in the Irish market,” says Martin.

In addition to traditional bank debt, options include mezzanine finance, private equity, convertible loan notes, vendor finance and there is also the option of using a mix of bank and non-bank lenders to optimise terms, he says.

Alternative lenders can play a useful role, agrees Laura McBride, partner, PwC Corporate Finance. “In return for a higher interest rate, alternative lenders may provide a greater level of debt than mainstream banks with potentially more flexible repayment terms. This debt is typically secured on the assets and cashflows of the business similar to mainstream bank funding.” The acquiring parties in a MBO can also employ strategies to minimise tax, increase flexibility and reduce debt requirements, McBride says.

MBOs typically use newcos – a newly created company formed to facilitate the transaction – to acquire the company, she says.  “This can ensure that the interest cost can be offset against tax and provides flexibility to allocate shares across the management team.  

 “Vendor loan notes or earn-outs can also reduce the level of debt required for the buyout.  “In this situation, the vendor is effectively paid out of the future profits of the business and, in the case of earnouts, only gets paid if the business performs well in the future.” 

 Given the challenges associated with transferring the business to new ownership, it is important that the business is not over leveraged through its borrowing. The introduction of new equity providers to support an MBO, in the form of private equity, venture capital or high net worth investors are options that can be considered.

James McMenamin, partner, corporate finance at PwC.

“The most obvious way to ensure that the MBO is not overburdened with debt is to minimise the overall price payable for the company,” says James McMenamin, partner, corporate finance at PwC. “In situations where the vendor has a loyal management team and is not focused on maximising the consideration, this can be achieved.”