Debt-funded MBOs – An alternative approach to management buy-outs

HMT announced this week that we have advised the management team at digital marketing agency OMM to complete their Management Buyout (MBO) of the business, with the support of alternative debt provider Thincats.

OMM represents the latest transaction for HMT in 30 years of advising on MBOs, which remains one of the most popular deal structures for existing shareholders and management teams alike. In almost all cases however, the deal requires significant capital that is beyond the means of the purchasing management team. As such, attracting external funding becomes the most critical part of any MBO project and is one of the critical roles that HMT undertakes on a process.

A common route is to gain sponsorship from a private equity investor in exchange for a majority equity stake in the new ownership structure. Gaining the experience, resource bandwidth and follow-on capital of a seasoned investment firm can make a lot of sense for the MBO team. That’s especially true when the growth strategy includes a material change of direction through product, geographical or acquisitive expansion.

However in the right circumstances, as was the case with OMM, a debt-funded MBO can offer an alternative approach. An “inside” deal can be arranged by using a fixed-return debt instrument alongside the vendors reinvesting a share of their proceeds into a subordinated loan note or agreeing a deferred consideration structure. There are a range of advantages – sensitive business information isn’t shared externally, the MBO team retains more of the equity and there is no pressure to exit under a 3-5 year investment horizon. Most of all, passing control to a team who already know the business well can offer the smoothest route to transitioning ownership within an overall quicker and simpler process.

A debt-funded deal is most accessible to companies serving resilient demand in growing markets with strong cash generation that can service the additional debt burden. Lenders will consider MBO financing as riskier and more complex than a typical commercial loan because of the inherent uncertainty that a change of ownership can bring and the higher quantum of debt required.

For the most attractive opportunities with the most credible management teams, bank and private credit fund lenders have appetite to support with 3-5 year term loans secured on the future cash-flows of the business. For transaction sizes up to £25m, achievable debt capacity can range between 2 – 4x sustainable annual EBITDA with varying degrees of amortisation and bullet repayment available.

Engaging an experienced advisor to both structure the deal and procure the most appropriate financing is a key initial step for management teams and shareholders contemplating a debt-funded MBO. With access to a wide-range of prospective lenders, the HMT team uses their experience to articulate and position the debt opportunity to the most relevant funders achieving the best possible terms through a coordinated process.

If you would like further information or advice on how HMT can support your MBO aspirations, please get in touch.

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Andrew Thomson

Partner