Maybe the New Owner is in the Office Next Door…
When we at Quazar assist Sellers/Owners of a business, we take them through a series of questions that we refer to as “Exit Strategy Options.” One is selling to the existing management team or some combination that includes the company’s key employees – a Management Buy-Out (MBO). What follows is a practical and common sense approach to a MBO.
Sellers typically say “my managers may be a good fit, but they can’t afford to pay what I’m looking for” or “I don’t want anyone to know that I’m selling, especially my key employees.” These are honest and natural “gut” responses. Why rock the boat if your President or General Manager, CFO, CEO or COO can’t even get off the starting line?
When we ask the seller if anyone in the company has the desire to own the business as well as the ability to run the company day-to-day, we often get a non-committal “maybe.” That starts us down the path of exploring a potential MBO.
For the purposes of this article, I will assume that one or more of the company’s key managers would like to own the company, knows how to run the current business and has the ability to continue growing the top and bottom line. The only real issue is securing enough capital to buy the business. Let’s refer to these potential buyers as the management team (MT). The MT could be one person or could be multiple employees.
At Quazar, we have a basic belief that goes something like this: find the best buyer for a business and, if it is the MT, don’t let the perception of their lack of cash stop the sale.
As Owners / Sellers, Ask Yourself These Questions:
Who else, besides the MT, could keep the business running with little or no interruption to the day-to-day activities? Our experience has been that a MBO normally results in less stress on the ongoing business compared to a third-party sale.
Who better to keep employee moral high and potentially get the benefits of being the “underdog” new owners? Everyone roots for the little guy. The rest of the company may view the purchase by a MT as “one of their own” getting a chance of a lifetime.
Do I need a stock sale? Often times the MT will be very flexible on the deal structure as it has the benefit of the entire history of the business including the skeletons in the closet. It may be less intimidated by the unknown liabilities that may concern a third-party buyer.
How about the dreaded due diligence performed by a buyer? Normally MBOs dramatically shorten the time necessary for a buyer and their lenders to get familiar with the whole business. This can save time and money while putting together the purchase agreement and financing necessary to close the transaction.
Will you, the seller, need ongoing compensation or benefits such as health insurance, consulting fees, a board seat or other potential tax-deductible* expenses to the MT? The MT may be able to offer these to you, whereas an outside third party may not.
How about that company boat (feel free to fill in the words; car, plane, pictures, horse, antiques, etc.) that winters in the warehouse? Our experience has been that the MT can be very flexible in buying/transferring non-core business assets out of the company (make sure you get tax advice first*).
Sometimes the MT can be more flexible with “Reps & Warranties” in the negotiation of the purchase agreement. The MT may not need the seller’s full warranty on the inventory.
The MT may be able to be more forgiving with holdbacks, baskets and future warranty claim expenses than a financial buyer would be.
Challenges You and the MT May Face:
Plan your approach the MT about selling the business to them. If it turns out that the MT does not buy the company, you will likely need them in place to maximize your sale price to an outside buyer. I recommend talking to your attorney, accountant and M&A advisor before you start serious conversations with your MT.
Most MBOs need some portion of seller financing. Sure we tell our clients to only accept cash, but the MT will probably need your show of support to convince the bank or other sources of capital that you, the seller, are committed to the company’s long-term success. Nothing says commitment like cash! The risk of taking back a note is you may not be paid any portion of it. This is very important if you carry back debt; you must be in a position to go forward with your life if you aren’t paid. Every situation is unique, but I would not advocate taking back a large portion of the purchase price in a note.
The MT that starts the process of buying the business may not be the same team at the finish line. Often times, when a group of employees wish to buy the company they work for, we tell them to go home and tell their significant other that they may need to take all of their cash out of the bank and maybe some retirement money, mortgage the house and perhaps sign on a personal guarantee at the bank. I recently sat down with a group of potential MT buyers and told them just that. At our next meeting 30 days later, we had a substantially smaller team of potential buyers! Make sure the MT is committed; even in a straightforward transaction the purchase process can be very trying for all parties involved.
There may be some interruption to the day-to-day business of the company. Suggest to the MT that try to limit the amount of company time used for purposes of putting the deal together. The MT will need to arrange financing, hire professionals, purchase insurance, attend meetings, obtain appraisals and work with a large variety of support people to get the sale closed. We find that having one member of the MT as the spokesperson reduces the distraction and stress on the ongoing business.
Once the MT retains their support team of professionals, attorneys, accountants and M&A advisors, there more than likely will be some friction. Advisors are paid to represent their clients and they can sometimes get a little overzealous and expect or demand too much. The MT is often times less experienced in working with professionals and allows them to take too much control. During the selling process, it is a good idea to have rational and experienced professionals on both sides of the table. Take a periodic reality check and make sure both sides are on track to accomplish the same goals they started with. It’s okay to ask questions and expect good answers. Keep in mind throughout the sale process that if the MBO falls through, you and your management team must be able to continue working together on Monday morning.
Management Buy-Outs are not for every business but when they are a fit, MBOs can be very rewarding for all parties involved.