Employee To Entrepreneur: Successfully Executing A Management Buyout

Executing a management buyout is an excellent strategy for owners to monetize the company they built from the ground up. Allowing the company’s top executives to take ownership lets the owner step down confidently.

They can leave operations in safe hands, knowing that the business will continue to scale and remain profitable.

A management buyout or MBO is particularly advantageous for a family business operating in a small town. The owners can leave behind a legacy carried forward by the local employees who have been instrumental in growing the company.

Public companies and giant corporations may also engage in such transactions by allowing a specific unit to break away. The smaller business continues to operate independently, with the management acting as its new owners.

Executing a management buyout is an intricate process that involves several steps, with due diligence forming an essential component. Here’s everything you need to know about how it works.

Executing a Management Buyout – Understanding the Step-by-Step Procedure

When the company’s top management purchases it in part or entirety from the owners, the M&A deal is a management buyout. Typically, the top executives raise funding from third parties to complete the transaction in a combination of equity and debt.

If a large portion of the company’s price is paid using these third-party financing methods, that’s a leveraged buyout. At times, the original owners may choose to accept stock or shares in the new company in lieu of part payment. Or choose to stay on as a consultant until the business is stable.

Step 1 – Demonstrating Business Acumen and Capabilities

Before initiating the company purchase, the management must plan the entire process in detail. For starters, they must demonstrate adequate business acumen and capability to run the company efficiently and profitably.

Company owners will likely accept the offer only if the management is trustworthy and competent. On their part, the executives should come up with the right game plan to take over the company. This plan starts with a detailed assessment of the company’s financials, current status, and viability.

The objective is to view the transaction as any other M&A deal–an opportunity. Next, the executives must conduct market research and evaluate the company’s existing product portfolio and optimum product-market fit. Having gathered the necessary data, they can value the business accurately.

At the same time, the management should constantly communicate with the owners about their intentions. Communication is crucial for building credibility and ensuring transparency in the deal.

If the company is underperforming, the management should have a game plan ready to turn it around. Communicating this plan to the owners will reassure them that the business is in safe hands.

Step 2 – Estimating Fundraising Strategies

Now that the management has a fair overview of the company’s value, they must plan to acquire the asset. To do that, they must build a financial model and create a list of potential investors they can approach. Depending on the type of investors, they’ll draw up the relevant terms and conditions.

While the initial valuation gives executives an estimate, owners and investors may conduct their own valuations. Preparing for aggressive negotiations is always advisable, as is retaining the services of expert advisors. These professionals can direct the acquisition and assist with funding.

The management may also want to estimate the funding they need to execute their growth strategies. Assigning responsibilities to individual board members according to their skill sets and experiences is a crucial planning step.

Aside from funding, the future owners must also plan their strategies for retaining core employees. This is a good time to connect with the workforce, shareholders, and other concerned entities to inform them about the buyout. Providing details of how the deal can impact them ensures their buy-ins.

Step 3 – Approaching the Owners with an Offer to Purchase

Building credibility and planning the acquisition can take months of preparation. But, once that is done, the management is ready to approach the owners. The open communication lines they have built now enable them to have an informal conversation where they put forward their proposal.

Alternatively, the management can send out a formal letter outlining their proposal, terms, and conditions. If the owners have been considering an exit, they may also have other offers. They may weigh their options and assess the best candidate suitable for managing their company.

Oftentimes, when the owners are ready to retire, they may approach the management with an offer. Depending on the value they estimate, further negotiations can take place. The executives can consider the viability of the offer and if they can raise the required funding and make profits.

Step 4 – Raising Funding for the Purchase

Executing a management buyout typically involves a substantial sum of money, which is why buyers may need external funding. Management may start off by investing in some of their personal assets and money.

Demonstrating that they have skin in the game could make it easier to convince investors that the company is viable.

When raising funding, executives approach sources like banks for loans or debt financing, which allows them to retain equity. Seller financing is another option where the owner agrees to receive a part of the compensation later.

The seller may also accept an earnout deal and receive a portion of the profits. Staying as an investor and receiving stock is another option. Other funding sources include mezzanine finance, leveraged buy-outs, and private equity firms.

Using the company’s assets as collateral to raise loans is also an option. However, the company retains ownership and control over the assets until the loan is paid off. Depending on the amount of funding needed, the management may also choose to raise personal loans to fund the buyout.

Executives may leverage their homes, non-cash assets, and pension plans as collateral to raise money for the buyout. Strategies like these allow them to avoid dilution and retain decision-making rights in their purchased company.

Relying on mezzanine lenders, venture capitalists, leveraged lenders, and private equity firms typically involves ceding board seats. The management may want to avoid this situation.

Keep in mind that storytelling is everything in fundraising. In this regard, for a winning pitch deck to help you here, take a look at the template created by Silicon Valley legend Peter Thiel (see it here) that I recently covered. Thiel was the first angel investor on Facebook, with a $500K check that turned into more than $1 billion in cash.

Remember to unlock the pitch deck template that is being used by founders around the world to raise millions below.

Step 5 – Conducting Extensive Due Diligence

As with any M&A and fundraising deal, due diligence is crucial for all the parties involved. The owners, investors, and buyers must conduct meticulous research into the company to understand its actual value and viability.

The due diligence process is speedier when executing a management buyout since board members typically have all the relevant information. Even so, they should also ask the necessary questions to mitigate risks. Digging into potential previously unknown liabilities is critical.

For instance, examining IP ownership and usage rights, ongoing litigation, the possibility of a primary customer pulling out, or asset liens. Issues like these can negatively impact the company’s stability and profitability in the future. All the stakeholders would want information about them.

Retaining the services of professionals is the key here. The team will conduct market analysis, confirm compliance with regulations and legal obligations, and run financial projections. Accountants on the team may also examine statements from previous years to ensure a robust financial base.

Any liabilities that can impede the company’s potential for scaling should be identified and addressed during the due diligence.

Step 6 – Negotiating the Terms of the Management Buyout

Legal teams on both sides now draw up the purchase agreement and other acquisition documents to conclude the deal. Since investors will fund the deal, they may include their terms and conditions to secure their stake.

At this point, it is also crucial to clarify how the new owners will divide up the equity among them. Creating documentation clarifying members’ rights and responsibilities is essential to avoid confusion and disagreements later.

If investors bring in board members, agreements will detail their roles in the company under the new ownership. An essential facet of the negotiations is working out the transfer of Intangible Assets to the acquirers. For instance, any internal knowledge, IP, and data that only the owners were privy to.

Step 7 – Closing the Deal

Once the deal is signed, the management becomes the company’s new owners. It is always advisable to restrict broadcasting information until the deal is finalized.

Further, executives must ensure that the company remains in operation throughout the deal. Business must go on as usual regardless of internal activities.

Advantages of a Management Buyout (MBO)

Management buyouts have several key advantages for all the stakeholders involved in the deal.

For Investors

• Hedge funds, giant corporations, and high-profile investors may encourage management buyouts that enable companies to go private. This strategy enables the business to streamline operations and raise profitability without public scrutiny. Releasing an IPO would work well once it is stable and attains a higher valuation.
• Private equity firms are open to backing an MBO involving a highly-experienced board of directors owning a company. They rely on the business acumen and expertise of the members to scale the company profitably for rich returns.

For Sellers

• Large corporations accept management buyouts to cut loose smaller divisions that are no longer a part of their core vision.
• Company owners understand the tactical advantage of selling the company to the executives. This deal protects its confidential business secrets, IP, and IA that would have been disclosed to external acquirers.
• Executing a management buyout typically takes much less time than selling to other buyers. That’s because the buyers and sellers are acquainted with each other and the company’s viability.
• An internal management buyout incurs lower costs than when selling to external buyers.

 

C-Suite executives looking to purchase a company have a distinct advantage since investors focus on the team’s skill sets and core talent. Before you create a pitch deck, check out this video, where I have explained in detail what investors look for in founding teams. Use the tips to enhance your deck and get the funding you need.

For the Management/Buyers

• The top executives can benefit from direct rewards the company generates, which is fair compensation for their hard work and dedication.
• Such teams are confident of their skills and expertise to run the company profitably and scale it quickly. They are also willing to invest their own resources toward scaling the business.
• As opposed to purchasing an unknown asset, members can invest in a company they are familiar with and know its potential. This factor lowers the risk levels and raises success rates.

For Employees and Customers

The company remains functioning as before without the challenges that often accompany a buyout. Transitioning to a new company culture and navigating the integration process can be difficult for employees. Such transitions often lead to employee attrition and loss of core talent, impacting the company’s stability.

Customers can also rest assured of the continuity of the products and services they have come to rely on.

Downsides of Management Buyouts

Despite the many advantages, MBOs are not without downsides.

• Many known brands are successful and profitable because of the company leader that customers and stakeholders believe in. If they were to step down, that could shake confidence in the company.
• The management may have to change their mindset from employees to owners, which they may not be able to handle.
• The company owner may not be able to value the company accurately.
• There can be a conflict of interest between the owners and management. Members are known to sabotage the company to bring down its value and acquire it for a lesser price.
• Raising funding to purchase the company can be a challenge. The deal may fall through if investors are not convinced of its viability.
• Smaller units breaking away from a publicly traded company may risk being accused of insider trading.

To Wrap Up!

Executing a management buyout may involve fewer challenges than a typical M&A deal. The process is fairly streamlined because the sellers and buyers are familiar with the company’s workings and potential.

As a result, company owners who are ready to retire or exit the company to start another consider this option. They can step down and leave the company in capable hands with assurance of its stability and long-term success.

Such deals also work well for large publicly traded corporations. They can separate a particular unit and allow it to continue operating independently. At the same time, the larger company may retain an ownership share in the breakaway through equity.

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