By Katherine Broadhurst, partner at Azets 

Management buyouts (MBOs) are a popular option as a succession route. Katherine Broadhurst, partner at Azets looks at some of the MBO funding options available.

There are a number of positives a Vendor may see in an MBO over selling to an external buyer: potentially better job security for the workforce; continuity for customers and suppliers; less disruption overall as the deal requirements are completed with full cooperation and understanding; and a greater chance of success and legacy, as the management will already have an in-depth knowledge of the business, its products, services and markets.

Businesses understand the value in this knowledge, which has led to us seeing Employee Ownership Trusts become an increasingly popular variation of the traditional MBO.

It is important with an MBO that preparation time is used positively, providing an opportunity for the advisors to work with the management team to ensure they clearly understand financial information, start to think strategically and line up any funding required for the final transaction.

The specialist team at Azets has seen significant MBO activity in recent years and a key reason for this has been the availability of debt funding and Vendors being prepared to form part of that funding package themselves through deferred consideration. In the last 18 months the West region Corporate Finance team, have advised on 11 MBO and EOT transactions.

Financing a buyout through management equity is a potential route but rare - it is a common misconception that the management team needs to fully fund an MBO by itself. Typically, those taking on the business will invest proportionately based on their proposed role and their own financial circumstances, in the knowledge that their personal contributions convince other lenders of a clear commitment to the long-term success of the business.

Deferred consideration is involved in the vast majority of MBOs and is effectively the Vendor acting as a funder. . Few transactions, whether 3rd party sales or MBOs involve full consideration being paid immediately due to the significant sums of money involved, the challenges involved in raising funding and a wish to ensure the Vendor is engaged in providing a smooth handover. Third-party lenders may require an element of deferred payment to ensure the vendor is also committed to the transition. High street banks and alternative lenders such as Shawbrook and Thincats have all been supportive of MBOs in recent years.

Where there is a difference of opinion on value, payments made after completion may actually be an 'earn-out', where some of the consideration is payable based on the company achieving future trading performance targets. In this case, clear legal definitions of the targets and their measurement is required.

MBO funding is also available through private equity firms with an investor acquiring shares in the business, often as a minority shareholder. The total finance is often split between a debt and equity elements. The investor is paid interest on the debt element, potentially dividends as a result of the shareholding and will seek to support growth in the business to benefit from capital growth . In general, private investors support businesses where significant capital growth is expected and where they are able to realise a return through a sale of their shares, commonly in a period of 3-5 years but potentially up to 7/8 years.

Many MBOs still rely on traditional bank finance including loans for the transaction and invoice finance for working capital and the new management team will need a robust financial plan in place to demonstrate it can meet the bank's repayment and security requirements. Furthermore, different funding options will have different tax implications and therefore getting appropriate advice on a coordinated basis is important.

Whichever route is chosen, planning ahead is essential for a successful MBO; historic financial information and projections need to be robust and the management team will need to demonstrate strong knowledge of the business and an ability to replace the Vendor in all aspects of their role. It can be an interesting time as the dynamics move between the parties as the transaction progresses. This is necessary to build the funder's confidence and belief in the management team's ability to successfully continue the business.

For further information and advise, please email Katherine Broadhurst at katherine.broadhurst@azets.co.uk or call 02920 549939.