Steps in a Management Buyout

/in , /by Al Statz

As a friend of Exit Strategies you know us as M&A brokers and appraisers, but you may not know that we advise on management buyouts.

By management buyout (MBO) I mean selling a company or business unit to managers and key employees using a combination of equity and debt. The assets and cash flows of the company are used to finance most of the purchase price, with the equity portion supplied by management or a Private Equity investor, depending on the size, profitability and nature of the company.

Business owners who choose the MBO exit option typically have strong non-financial motivations. Don’t get me wrong, price is important to them. However, factors such as company legacy, employee welfare and local community are often equally and sometimes more important.

Typical MBO Steps

When advising company owners on management buyouts, we start by understanding our client’s short- and long-term goals, needs and circumstances. If an MBO appears to be appropriate, we will:

  1. Prepare an independent business valuation (fair market value) to provide guidance on pricing and feasibility
  2. Work with financial, tax and legal counsel to determine a deal structure that achieves the owner’s liquidity and income goals
  3. Obtain confidentiality agreements from interested parties
  4. Meet with managers to understand their interest level, goals and resources; educate them on the MBO process; confirm feasibility
  5. Develop a transaction roadmap
  6. Collect details on buyer experience, credit, funds and collateral
  7. Prepare a confidential information memorandum, source documents and disclosures to fill management’s knowledge gaps and explain the merits of the transaction to their advisors and lenders
  8. Recommend wealth management, legal and tax professionals (if needed) and coordinate with them
  9. Evaluate debt financing options (including seller note) and the potential of “rollover” equity
  10. Determine if private equity capital is necessary or desired, and available
  11. Recommend and liaise with best-fit debt and equity providers
  12. Propose terms and facilitate sensitive negotiations while buffering emotions
  13. Draft a nonbinding memorandum of understanding on key deal terms, transaction process and timeframes
  14. Facilitate buyer, seller and lender due diligence
  15. Assist buyers with financial models, business plans and shareholder agreements as needed
  16. Work with the parties’ legal teams to finalize definitive agreements
  17. Advise on leadership transition
  18. Satisfy closing conditions, resolve problems that arise, and maintain momentum for a timely deal closing

Every buyout is unique. We add, remove and rearrange steps as needed, and help both sides navigate the process. In some cases, management, not the owner, initiates the buyout. Here is one example.

Biggest Challenges

Owners and management employees usually lack the time and deal experience to complete successful buyouts on their own. The interdependent owner-employee relationship raises the stakes for all parties and magnifies the consequences of a failed negotiation. Three areas seem to be especially challenging for owners and management:

  1. locking in a fair purchase price (business valuation),
  2. determining the right deal structure, and
  3. financing

Most Common MBO Mistake

For a management buyout to succeed, a business usually has to have a solid earnings track record in order to prove it can service the debt. Management must demonstrate the requisite skills, experience and commitment. Putting everything in place can take months or years of preparation. Waiting too long to begin this process is the most common mistake I see owners make.

Backup Plan

Of course, there is always the possibility that the MBO will fall through, and you should be prepared for that possibility. That may involve creating incentives for management to stay on and being ready to market and sell the company to third party strategic and/or financial buyers.

The First Step

If you are considering selling your company to management some day, feel free to call us to discuss your goals and needs, confidentially.

Al Statz is the founder of Exit Strategies Group and a senior M&A advisor in the firm’s Sonoma County California headquarters. Email Al or call him at 707-781-8580.