“Have your cake and eat it” – not something you come across often in the world of MBOs, but obtaining the vendors’ assistance is now a common feature of the MBO landscape.

This means much more than the owners helping their management team buy the business, so;

• what does it mean?
• when are they appropriate?
• why are they so appealing?

What does it mean?

You may come across various acronyms such as “RAMBO” (Rollover assisted MBO) or “VAMBO” (Vendor assisted MBO), they all refer to the same thing; the vendor assists management by being part of the deal’s structure. This is typically achieved by the vendor retaining some form of equity, loan note or deferred consideration in the MBO team’s acquisition vehicle (or “Newco”).

The traditional MBO comprises a Newco which raises external finance (debt and often equity) to purchase the business. However such external finance may often not be available, or at least not for the full consideration. This is when the vendor steps in.

The vendor can effectively fund part or all of the MBO team’s funding through any combination of mechanisms: deferred consideration, loan notes, preference shares, ordinary equity, options and warrants and numerous variations thereof. There are no pre-determined rules or benchmarks – whatever works for the unique circumstances of each deal.

When are they appropriate?

Vendor assisted MBOs can only work in certain circumstances. For example:

• there is a willing vendor who is happy to leave some value “at risk” behind in Newco (eg they have faith in the future of the business under the MBO, or they do not need all the money now/ are willing to wait/ want to share in the future potential etc);
• the funding capacity of the business does not meet the vendor’s price expectations (eg venture capitalists are not interested, the debt capacity is low due to recent losses or a low asset base) and hence a mechanism is needed (ie the vendor) to bridge this funding gap;
• the vendor has few alternative exit options (eg no trade buyers or flotation prospects); and
• the vendor wants to pass on the business to the management team to “keep it in the family” and away from competitors or big corporates.

Of course, the core requirements for any MBO must also be in place: a robust business plan, strong, backable management team and overall rationale for the deal.

An example of how they work: a business is valued at £10m, the vendor owns 100% and wants to sell to management. Only £5m of external finance can be raised. Newco will therefore buy 100% of the shares in return for £5m cash and £5m of “deferred value”.

This is where the vendor assistance comes into play. £5m of value is being left behind: at the simplest level this could be a deferred consideration payable over the next few years, perhaps as a secured loan note (with interest income for the vendor in the meantime). The vendor may prefer to hold it all as equity (equating to 50%) perhaps earning a dividend.

There are numerous variations on this theme – loan notes and equity, ordinary and preference shares, secured and unsecured, interest bearing or dividend yielding. Ultimately, if it works, then it’s appropriate.

Why are they so appealing?

So, why are vendor assisted MBOs increasing in popularity? Why do advisers often consider them first when structuring a deal? Well, they make compelling logic for vendors and MBO teams alike.

If vendors are willing to assist, then it’s a “no brainier”, as it:

• provides them with an exit they may not otherwise achieve;
• provides the opportunity to generate substantial future returns, depending on the structure adopted (eg interest, dividends or future capital gains when the MBO exits);
• can generate cash now and cash later, in a tax-efficient way (structured correctly, vendors only incur capital gains tax when they actually receive the cash); and
• ensures the business ends up in a good home, retaining continuity and confidentiality (especially from trade buyers).

It should also be the first option MBO teams explore, as it has many advantages for them, as it:

• typically provides more equity for management than alternatives;
• retains the status quo, without external involvement eg from new owners or equity investors;
• puts in place a sensible and affordable funding structure; and
• is typically a cheaper and more viable deal structure than traditional VC type deals.

Summary

Many MBOs follow a traditional structure with debt and equity funding providing full exits for vendors. But, when the right ingredients are in place, there is a great opportunity for all concerned to structure a vendor assisted MBO. Both sides really can have their cake and eat it!