Management buyouts: how an MBO is funded

A management buyout, or MBO, is a purchase of a business by the managers who already run it. The managers become the new owners, usually by buying the shares of the company from the existing shareholders, who may be a founder, a family or a parent group.

Buyers like the idea because they already know the customers, the staff and the numbers. Sellers like it because it can mean a quieter, more predictable sale to people they trust. The difficulty is the price: a business is usually worth more than a management team has in savings, so the deal needs outside funding.

The mechanics are those of any business purchase: agree a price, check the business, sign the legal documents and pay. What is different is who is buying, and that the buyers are also the people the business depends on.

A management buyout is usually funded in layers, because no single source is likely to cover the whole price. The table sets out the layers that commonly appear. Which of them a particular deal uses depends on the business, the price and what each provider is willing to do.

Capzy arranges debt finance, not investment. If outside equity is part of your plan, that conversation is with the investor and your solicitor, and we only help with the borrowing side.

Lenders look mainly at whether the business can pay the debt from its own cash flow after the managers take over. The sellers’ asking price matters less to them than what the business earns.

• Earnings and cash flow: measures such as EBITDA and free cash flow show how much is available to service debt.
• Coverage: the interest cover ratio shows how comfortably earnings cover the interest.
• The price: a lender will test whether the price looks reasonable against how the business is valued.
• The team: their record in the business, and whether the buyers can run it without the seller.
• Security: what assets or guarantees support the loan, which may include a personal guarantee from the managers.

Each lender applies its own criteria, and any offer is subject to status. Do not assume that a lender that funds one deal will fund another.

An MBO normally runs through the same stages as any purchase, with the funding talks running alongside the negotiation.

1. Agree with the owners, in principle, that they are willing to sell to the management team.
2. Get the business valued and agree a price, ideally with an accountant who is independent of the sellers.
3. Plan the funding: how much the managers put in, how much the sellers defer and how much is borrowed.
4. Carry out due diligence, so that you and your lenders have checked the accounts, contracts, tax position and any legal disputes.
5. Negotiate the sale agreement with your solicitor and agree the finance terms.
6. Complete the purchase, pay any duty on the shares and update the records at Companies House.

A solicitor and an accountant are not optional here. Managers are on both sides of the table, as employees and as buyers, so independent advice matters more than usual.

What happens to employees depends on how the deal is structured. GOV.UK explains that TUPE protects employees when a business changes owner and that, for a business transfer, the identity of the employer must change to be protected. Where the managers buy the shares, the company stays the employer, so ask your solicitor whether TUPE applies to your deal.

Where TUPE does apply, the new employer takes over employment contracts, including the existing terms, holiday entitlement and continuity of employment, and employers must inform and consult employee representatives before the transfer.

The company records change too. A person with significant control is generally someone with more than 25% of shares or voting rights, or who can appoint or remove a majority of directors, and you must tell Companies House within 14 days of confirming a change to that information.

Buying shares usually attracts a tax or duty of 0.5% of the price. If you buy electronically you pay Stamp Duty Reserve Tax, and if you use a stock transfer form you pay Stamp Duty when the transaction is over £1,000. The form and the duty are due within 30 days of the form being signed and dated.

The main risk is taking on more debt than the business can comfortably repay. The business must now fund the repayments as well as its normal costs, and the managers may have signed guarantees that put their own assets behind the loan.

• Paying too much because the sellers are friendly or the team is under time pressure.
• Relying on figures that have not been checked independently.
• Leaving too little working capital after completion to cover wages, suppliers and tax.
• Not planning for the sellers’ knowledge and relationships leaving the business.

The alternatives depend on which side you are on. If you are a manager, you could buy a business outside your own employer, buy in stages or take on a partner with capital. If you are an owner, you could sell to a third party, to a competitor or to a mixed buyer group that includes the managers.

A buyer outside the company is usually treated as an acquisition, and our guide to acquisition finance covers how that is funded. For smaller deals, the same lenders that fund working capital or assets may be relevant, which you can see in the lender directory.

Capzy is a credit broker, not a lender, and is paid by the lender. We help you see what borrowing may be available for part of a deal and introduce you to lenders that may fit, but we do not arrange equity or investment, and we do not give tax, legal or accounting advice.

If you want to explore the borrowing side, you can check your funding options with a soft search that does not affect your credit score. A full application to a lender may involve a hard search, and any offer is subject to status and lender criteria.