1 June 2017
During the recession of the late 2000s and early 2010s when the availability of bank debt was limited, Management Buy-Outs (MBOs) were difficult transactions to get away with. During that time, unless the business was suitable for private equity investment (in which case the banks would still probably have taken an interest), the only way to fund MBOs was to use the free cash on the balance sheet as the upfront consideration and then get the vendor(s) to effectively play the role of the bank by taking their remaining consideration on a deferred basis.
In today’s market, where the banks are showing a real willingness to lend again and the Asset Based Lending (ABL) market is awash with new entrants all competing to lend money, the prospect of realising an MBO transaction with a high proportion of the consideration being paid on day one is much more realistic. Vendors can once again look to the banks to fund as much as say two and half times the future cash flows of the business, which in combination with a slug of ABL money (eg. finance raised against unencumbered assets such as plant or stock or via a confidential invoice discounting (CID) facility) and the free cash on the balance sheet can amount to a sizeable chunk of the likely consideration of a deal. Yes, the vendors will still probably have to accept some form of deferred consideration, but that’s common on many deals these days; private equity and trade included.
To put it into a worked example; the owners of a business generating say £0.5m of earnings before interest, tax, depreciation and amortization (EBITDA) with £0.2m of free cash on the balance sheet and an unencumbered sales ledger of £0.6m of eligible debtor balances may look to sell their business to management for £2.2m, being a four times multiple of EBITDA plus the free cash. With market forces as they currently stand, management might look to fund the deal as follows:
- £1.0m through a term-debt bank loan
- £0.2m of free cash
- £0.5m through a CID facility
- £0.5m of deferred consideration
Under the above example, more than 75% of the total deal consideration is funded on day one and, to a large extent, the deal is de-risked from the vendor’s perspective. Yes, the deferred consideration will undoubtedly have to rank behind the bank loan and the CID facility from a security perspective, however, on the assumption the business performs to plan, there should be free cash flow in the business after servicing the bank loan to repay the £0.5m of deferred consideration over say two to three years. The vendors may wish to retain an interest in the day-to-day activities of the business to help protect the security of the deferred consideration, and proper advice should be sought in this regard to ensure efficient tax treatment on the deal consideration. However, it offers vendors a relatively secure way of exiting their business in a timely fashion with a good level of security over the total deal value.
Of course, every business is different and the numbers mentioned above are for illustrative purposes only, but the bank funded MBO has certainly returned to the market with a bang! If you have any questions regarding MBOs, please contact me or your local UHY corporate finance specialist.