Funding Tools for Business Managers

The Business Dream

For many business managers the opportunity to own the business they work for and in many cases have helped to build up, is one they would relish.

Despite, the long hours, undoubted pressures and stress, thousands of employees continue to dream of becoming their own boss. And increasingly this dream is becoming a reality. The attraction of a Management Buy Out (MBO) is that rather than starting from scratch, business managers have the chance to purchase a business they know inside out, a business with an established customer base, in a sector they understand. There has been a rise in M&A (Mergers and Acquisitions) with the latest M&A Leaders survey (conducted Mid-April 2014) figures showing $73.8 billion dollars in mergers and acquisitions. The strongest first half since 2011, this is twice the activity of the same period in 2013. The two major driving forces for these changes are desire for growth and industry consolidation.

Sectors such as Power and Energy, Real Estate and Infrastructure have recorded the most M&A activity in the second quarter. Dane Fitzgibbon, co-head of Capital Markets at UBS has reason to believe the market will remain “very strong” over the year, if global conditions remain stable.

A Hard Path

Businesses are typically sold to the management in a number of instances: if the business is part of a larger group that wishes to sell a non-core business, if the founding entrepreneur wishes to realise their investment and sell or if the business is a profitable subsidiary of a distressed parent company. An MBO might also be the preferred solution to the issue of management succession in a public or privately owned business.

A trade sale is also an option in each of these cases, but a successful business is run by good management and this can create an excellent opportunity for the existing management team to raise finance to buy the business. Continuity of good management reduces any buyer’s risk and it is this detailed knowledge of a business and the opportunities within it that enables the management team, backed by a financial institution to compete head on with trade buyers.

However, although the MBO is undoubtedly a fantastic route for managers to own their own business, the steps in the transaction are far from simple. Often the process is very complicated and extremely demanding and at the same time managers are still required to run the business.

Any management team considering a buy out for the first time should take the following initial steps:

  • Prepare a precise briefing paper on the main objectives of the transaction
  • Obtain preliminary, independent advice on the feasibility of the project
  • Be realistic in your valuation of the business
  • Consider how much finance is required and for how long
  • Consider your financial priorities and research all the finance options available to you
  • Make sure that your business plan can stand up to a potential funder’s scrutiny
  • Undertake due diligence to quantify areas of commercial and financial risk
  • In negotiation, be aware of the vendor’s objectives, be reasonable and realistic in your demands
  • Be patient, the transaction is likely to encounter problems at some stage
  • Do not spend too much time on the deal at the expense of your existing commitments.

The Right Finance Package

Having decided to go down the MBO route, the first hurdle faced by the majority of management teams will be to secure some sort of financial backing.

Funding Alternatives

Many of the conventional funding options used by small firms to cover operational expenses are not suited to financing an MBO. For example overdrafts, the mainstay of many businesses, are really designed for short periods of funding such as a temporary shortage of cash. While quick to arrange and relatively cheap, they are typically secured against property (thereby putting it at risk should any adverse situation occur) and, there will be an upper limit (usually fairly low) above which you will not be allowed to go without the permission of your Bank Manager. The serious draw back of the overdraft is that the Bank can demand instant repayment, which can cause severe and sudden cash flow issues.

Longer-terms loans are another alternative and if you know at the outset that you are unlikely to be able to repay the money you want to raise in the short-term a longer-term source of finance might be the answer. Loan terms vary from bank to bank of course. You can borrow money for periods of between two and thirty years and the rate of interest can be fixed, variable or at the monthly managed rate.

Some individuals also consider using their own personal equity to fund an MBO. The main advantage is that you are not indebted to any other organisation and are free to act as you see fit. However, this can also be a risky business and in the case of business failure can leave the individual seriously out of pocket or in the worst-case scenario personally bankrupt.

The source of funding most commonly associated with the Management Buyout is venture capital. Just as company owners have traditionally sought funding for their business through bank overdrafts or loans, management teams considering an MBO would normally go to a venture capitalist as their first port of call.

However, venture capitalists will usually ask for a seat on the board and a substantial stake in the business and many entrepreneurs hate the idea of handing over a slice of their company to an outside investor.

This in part explains why increasingly alternative forms of funding such as debtor finance are being used not just as a form of working capital, but also as a tool to support management buyouts.

Debtor finance allows buyout teams to borrow against the amount owed by customers. It can also bridge the gap between what management can afford and what the bank will lend and help individuals avoid having to invest large amounts of personal equity.

If a business has credit sales of $3 million it could raise up to $2.5 million in cash; this could be used to assist in the purchase of the business and then as a form of ongoing funding, to help with running costs.

A Working Partnership

Working with an experienced debtor finance provider can provide the foundations for a long-term working relationship. Venture capitalists are likely to want not only equity in the company they finance coupled with a say in the ongoing activities of the business, but also the freedom to determine their exit strategy from the business, at the moment in time that is most profitable for them.

In contrast, a debtor finance company will not seek an equity stake, and will not be working towards an eventual exit – rather they will seek a long-term financial partnership, offering support and flexibility as well as ongoing funding through invoice discounting. They can provide up to 80 per cent of the value of invoices as they are raised by the client company, providing timely cash injections and more secure liquidity during the initial stages of the MBO.

Furthermore, debtor finance is often able to provide a level of funding larger than other forms of funding, helping to raise the capital required for the MBO, but also achieve other aims such as improving creditors positions, ensuring tax liabilities are fully up to date and even purchase capital goods required for growth.

Management buyouts are never easy, even though they may appear to be the most straightforward option available to an owner-manager and are on the rise as owners of businesses are anxious to cash in for retirement or personal reasons.

However, with the right financial support and expert advice an MBO can be hugely satisfying and offer a once in a lifetime opportunity to take ownership of a known business and see it thrive and succeed.