The scope for a ‘DIY’ MBO

GEOFF HAZLEWOOD, a partner at Ashton KCJ Solicitors, looks at vendor-backed funding options for business sales

THERE has been much comment on the difficulty of sourcing funding, particularly for buy-outs and other business acquisitions.

Given the current economic climate, this is not surprising as almost everyone is exercising caution, not least the banks. It does, however, make it frustratingly difficult to get deals done, particularly for business owners who are looking to move on.

If you have exhausted the usual sources of funding (and do look around) it is possible for the vendor to effectively step into the traditional funder’s shoes and fund the deal instead. That does see the vendor taking on a considerable amount of risk, but there are ways of managing and mitigating that risk.

If there is sufficient cash in the business, it may be possible to utilise that, either in a share buy-back, or by distributing the money by way of a dividend to the buy-out vehicle, which in turn uses it to pay the vendor. As is always the case, however, you will need tax and accountancy advice to see if one of these methods is viable.

Next, there are the more usual forms of deferred consideration where the vendor waits to be paid over a period of time, either as simple instalments or as loan notes. Whilst never hugely popular with vendors, deferred consideration is fairly common, even where third party funding is available.

A variation on this is the earn-out, where additional consideration is payable on the future trading performance of the business (particularly useful if there is a difference of opinion over the value of the business). The debt could be secured in the form of a debenture or legal charge, but you would need to be mindful of any existing security of incumbent lenders.

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A further alternative, and one that provides an element of security, is to issue the vendor some shares in the buyout vehicle. This would usually take the form of some type of preference share that pays a coupon and can be redeemed (with the capital returned to the vendor over time). Such shares could also carry certain rights, allowing the vendor to re-assert control over the company if any instalments of deferred consideration were not paid. Although this does not give either buyer or vendor an entirely clean break, it would be an option to get things started, and when funding conditions improve, the remaining debt could then be refinanced.

This article is for general information purposes only and does not constitute legal or other professional advice. We would advise you to seek professional advice before acting on this information. Ashton KCJ is authorised and regulated by the Solicitors Regulation Authority (Recognised Body number 45826) and by the Financial Services Authority.