Management Buy-out Financing – Don’t Let Change of Control Jeopardise Your MBO
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Management teams undertaking a management buy-out (MBO) to acquire their company represent a compelling opportunity. However, the journey involves navigating various complexities, including valuation negotiations, resolving stakeholder conflicts, and navigating financial barriers. The most successful management teams manage these challenges through careful preparation, expert guidance, and alignment with the company’s objectives while focusing on operational success and stability during the transition.
Despite the strengths that management teams bring to the negotiating table, a significant financial barrier can arise. The deal’s success can be jeopardised if the company’s bank invokes a change of control covenant. Don’t let bank policy jeopardise your MBO. Keep reading to discover the benefits, challenges, and financial support available through management buy-out financing to support management teams engaged in an MBO.
Benefits of Management Buy-outs
An MBO offers several advantages over a traditional sale, particularly when the business has a strong management team. It can be a quicker process, as it eliminates steps like marketing the business and vetting the buyer. For vendors looking to exit swiftly, an MBO can provide a ready and reliable buyer, ensuring continuity in management. Due diligence is often quicker since the management team already knows the business, reducing the required information to assess compared to an external buyer.
Additionally, selling to a familiar, capable team reduces the risk of post-deal failure, as they are well-equipped to drive future growth and achieve the desired valuation.
Challenges of Management Buy-outs
While MBOs can be advantageous, offering benefits like management continuity and business knowledge, they can also pose significant challenges that can derail the process.
The following lists key disruptors that can impede the sale of a business to the company’s management team:
- Valuation disagreements can be contentious, with owners sometimes having unrealistic price expectations, leading to lengthy negotiations.
Management teams can best manage valuation disagreements by leveraging their in-depth knowledge of the business and engaging with valuation experts or online platforms. Corporate finance advisors and independent valuers provide impartial assessments of a company’s worth.
- Pressure to balance day-to-day operations can distract management teams from focusing on the demands of buy-out negotiations. After the buy-out, ownership transitions can disrupt operations – ensuring a smooth handover and maintaining stakeholder confidence is vital.
To maintain efficiencies, management teams can engage with professional services, such as project management, operations consultants, and financial experts.
- Securing sufficient financing can be a significant hurdle. MBOs require substantial capital, which management teams may struggle to raise. The buy-out is often jeopardised if the company’s current funder enacts a change of control covenant and withdraws financing.
Partnering with experienced independent funders to arrange management buy-out financing is a sound strategy to overcome the financial hurdles typically associated with an MBO.
What is a Change of Control Covenant?
A change of control covenant is a protective clause, often included in financial agreements, to safeguard the interests of the funder. It is a standard provision which addresses the implications of significant ownership or management changes within a company. It typically gives funders the right to take various actions, such as demanding immediate repayment of debt, renegotiating loan terms, or terminating the financing arrangement altogether.
While the company’s bank may invoke a change of control covenant and withdraw its financial support, this action is not necessarily a showstopper. If the benefits of an MBO outweigh the challenges, management teams have access to alternative financing options via specialised independent funders. Let’s look at a real case scenario to illustrate the transformative power of management buy-out financing.
Management buy-out financing – a real-case scenario
A well-known book publishing company faced significant challenges that threatened to derail its MBO negotiations. The publisher’s senior bank partner faced a challenging decision regarding the upcoming ownership transition. In reassessing its support, the bank withdrew credit as the buy-out significantly altered the funding arrangement and pushed the facility outside the parameters of the bank’s strategic objectives and risk management framework. As a result, the bank invoked its change of control covenant, preventing the new owners from assuming existing financing.
Without the bank’s working capital line, the management team’s ability to run the business and complete the MBO was seriously compromised. Wanting to divest from the existing relationship yet help service the deal, the banker referred eCapital to step in and assist with a management buy-out financing arrangement.
eCapital, is a leading independent funder in the United States, Canada, and the United Kingdom. This experienced team quickly provided a tailored $3.5 million (£2.75 million) management buy-out financing facility with an inventory sublimit tailored to support the MBO. This customised management buy-out financing solution gave the management team the necessary working capital to complete the sale, maintain operations, and drive growth.
The Transformative Role of management buy-out financing
Management buy-out financing offers versatile funding options instrumental in this case, showcasing its transformative potential across various industries. Whether through invoice financing or other bespoke funding options, management buy-out financing provides cash flow solutions that can help overcome obstacles in MBOs.
For management teams facing a change of control issue, management buy-out financing provides numerous advantages:
- Fast and flexible funding ensures immediate access to working capital, allowing the business to continue operations and complete the acquisition.
- Minimal covenants grant greater flexibility. Management buy-out financing features few restrictive covenants, leading to a more collaborative relationship with lenders and greater autonomy for the business to grow.
- Support for growth is enhanced as the facility’s borrowing capacity can increase alongside the business’s assets, such as receivables, inventory, or equipment.
- Straightforward qualification allows companies with creditworthy customers and valuable assets to qualify for management buy-out financing, even if their credit scores or business performance are not optimal.
Conclusion
Management buy-outs offer tremendous opportunities for skilled teams to take ownership of their success. However, a change of control covenant can create significant financial barriers, impeding the transition process.
Management buy-out financing solutions like those offered by eCapital can help management teams meet the capital demands of an MBO. This experienced commercial financing team can help assess financing needs and create a customised solution to maintain operational success and stability during and after the transition.
Contact us today for a free financing consultation and discover how we can help your business achieve its potential.
Key Takeaways:
- Undertaking an MBO requires navigating challenges like valuation negotiations, stakeholder management, and legal compliance.
- A significant hurdle in an MBO can arise if the bank invokes a change of control covenant.
- Management buy-out financing provides an alternative solution to secure working capital and support business continuity during an MBO.
- A recent case involving an established book publishing company highlights the vital role that management buy-out financing can play in ensuring the success of a management buy-out.
eCapital UK
eCapital Commercial Finance (eCapital) is a leading invoice financier providing funding facilities up to £4m to support the growth of SMEs through the provision of flexible working capital facilities. With five fully functional UK regional offices, its local teams are uniquely placed to respond promptly and purposefully to the cashflow needs of its clients. The business has grown significantly since its launch in 2001, providing over £12 billion of funding to businesses. It is majority owned by eCapital, a US based financial services business with interests in the USA and Canada.
