Management buyouts are financial transactions in which businesses are purchased by their management teams. It’s an exciting concept for a lot of managers because it allows them to use the experience they have in running a business on a day to day basis and apply it as an entrepreneur.
It’s a complex process and there are a lot of factors to be considered. For instance, the management needs to be ready to take on the new role and to have a clear idea of what the company will be like after they take over it.
One of the main things a new leader needs to consider is how to finance the buyout. It’s a long-term investment which means it needs to cover the costs but also leave enough cash to work with and handle day to day expenses.
Seller financing is exactly what it sounds like. The sellers provide the financing for the managers to buy their business out. This isn’t exactly the best option for the sellers and it’s usually used when there are no other options available – mostly when there are no buyers out there.
The price that’s paid right away is usually nominal, but there are other ways for the owners to be compensated. There’s a timeframe (ranging from 3 to 7 years) in which the new leadership of the company needs to return the money. This could be either a very comfortable option for the new owners or a quite difficult one, depending on how profitable the company will be after the buyout.
A bank loan
The most straightforward strategy for financing a buyout is the management taking out a bank loan and purchasing the company right away. It sounds simple but it also presents the biggest burden for the managers who will then be tied in with a loan for years to come.
It’s also important to note that acquisition loans work a bit differently than ordinary loans taken by individuals or even companies with a different purpose in mind. The buyers need to have excellent credit rating and provide proof that they’ve been paying taxes for years.
These loans are also sometimes backed by the government, especially if you’re buying a small company or one in an industry that’s supported by public funds (like green energy).
In some cases, the management can use the services of a private equity fund to raise the capital needed for purchasing the company. It’s not suited to all businesses, because equity funding focuses on large transactions. However, it’s a straightforward transaction in which everyone knows why they are getting into it.
The equity funds are looking for a fast return on investment like with any other loan or stock purchase. These goals need to coincide with the goals and plans of the buyers. There’s usually a time frame within which the business needs to financially stabilize, and it’s rarely more than 5 years.
The business plan the managers create for their new company must reflect these deals as well. That way the new ownership can plan their obligations ahead of time and have a productive relationship with the private equity fund.
Assumption of debt
This strategy is only available to certain businesses and it’s usually combined with other funding sources. It can only work if the company has a significant amount of debt that it can’t repay. The new company, meaning its owners, will then assume a part of this debt when purchasing the company.
It usually isn’t the only way used to buy a business out, since no one wants to buy a business that owes more than it’s worth. Most of the time the managers buy a portion of the company using some of the aforementioned financing methods and the debts get deducted from that investment.
In these cases, the new owners need to have a detailed plan for the future of the company. There is usually some sort of pivot in terms of the products offered or the clients pursued, because the company needs to change the ways that have created the debt in the first place.
Financing day to day activities
Purchasing a company and running it on a day to day basis are two completely different things. It isn’t enough for the management to obtain the funds to buy the company out, they also need to run it and cover the expenses for the employees and contractors.
It’s best to get a line of credit for these expenses. With a credit line, a business has a certain amount of funds available, but they can borrow and pay interest on the amounts they need at any particular time.
There are different ways of approaching a management buyout. The main goal is to choose the financing strategy that’s best suited to the business at hand and the plans you have for it.
Guest author, David Webb, is a Sydney-based business consultant,online marketing analyst and a writer. With six years of experience and a degree in business management, he continuously informs the public about the latest trends in the industry. He is a regular author at BizzmarkBlog. You can reach him on Twitter or Facebook.