A management buyout, or MBO, is a transaction where the management team acquires the assets or stock of the company from the owners. It is similar to a leveraged buyout in that, the management team does not have the necessary financing to purchase the company from the owners without third party financing. A management buyout is appealing to the management team because the rewards are greater as owners. Additionally, management can often feel stifled by the current owner’s strategic plan and desire to take the company in a new direction. One effective way to finance a management buyout is through mezzanine debt.
Mezzanine debt is a form of structured debt that lies between senior debt and equity in the company’s capital structure. It has many of the traditional elements of a loan such as a term, interest rate, covenants, and control provisions. Mezzanine debt also has several elements of preferred equity due to the warrant, which gives the lender additional return upside, ahead of the common shareholders. The benefits of funding through mezzanine financing include higher amounts of money with no personal guarantees to the owner or the management teams. Mezzanine debt is a long term loan that allows a company to go through a transitional period – be it an ownership change, an acquisition, a growth spurt, without having to worry about paying off the loan too soon. It is a patient form of capital that allows a company to confidently take a powerful growth step.
Mezzanine debt is based on the company’s cash flow. EBITDA is the earnings before income, taxes, depreciation, and amortization of a business. Lenders assess the riskiness of a business through assigning a multiple of EBITDA. For example, a multiple of 3 means that the total financing divided by the EBITDA is equal to 3. This is considered to be an average market multiple. Market multiples usually range from 2.5 to 4.0 times EBITDA. Mezzanine debt has the flexibility to support any type of corporate growth strategy, especially a management buyout.
Mezzanine debt is a great way to fund a management buyout because it can provide most, if not all, of the money needed to purchase the business. If structured properly, the mezzanine loan can help a management team purchase the business and take it in a new direction