A management buyout, or MBO, is when the purchaser does not have the necessary funds to be able to acquire a company it is interested in without obtaining some sort of loan. A MBO is a specialized form of an acquisition where the managers, specifically, of the company wish to secure a significant portion or all of a company from its private owners. To accomplish a successful MBO deal, the management team should focus on some key factors:

Management Skin in the Game: Management teams need to have some funds in order to induce the lender to make the loan. They need to pitch the lender on the quality of their investment and the sweat equity invested to date.
Debt Repayment – For a successful management buyout, the management team must have the capabilities to successfully pay off the principal and interest expenses without disrupting normal cash flow operations. Often, the debt load can crimp cash flow, and slow the company down. Having enough cash to curtail the loan and run the business is critical.
Reasonable Valuation– If management can purchase the company at below fair market value, they can use this favorable purchase price as part of their equity contribution. Lenders will respond to this if it is presented properly to them. While many lenders want to see at least 20% equity in the deal, some lenders are responsive to the quality vs. the quantity of equity argument.
Low working capital and High cash flows: If management can decrease working capital and increase cash flow, the MBO will likely be successful. This will lower the debt and give more financial flexibility, which is important when running a highly leveraged business.
Exit options: If necessary, is it possible to sell the newly acquired business for a price higher than the entry multiple that you initially paid for the company? Most MBO’s are in industries where there are other private equity backed businesses seeking acquisitions. It is good to understand the exit valuation multiples available in the market throughout various stages of growth.

As the Fed decides to ease interest rates, middle market acquisition financing structures will benefit in a number of ways. The underlying values of middle market companies will increase leading to a higher enterprise value and lower loan to value ratios for existing portfolio companies of acquisition financing lenders.

The role of acquisition financing is infrequently elevated above a functional transactional one. When a business needs financing to acquire, they go to the market and source acquisition financing to supplement their equity investment to close the deal. Despite existing in many different forms, acquisition financing is rarely explained in terms of the value it brings to the acquirer.

Acquisition financing underwriting usually focuses on business and financial issues that underpin the stability of cash flow. Providers of acquisition financing usually validate the durability of a company’s competitive advantage and the depth of its resource base. Environmental issues are usually not a major part of the analysis in today’s service and technology-based economy.

Key Ingredients for a Successful MBO Deal

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