One of the best investments you can make is buying the business you work for.
Owning your own business gives you control over your future; the business is yours to expand and you reap the rewards from your hard work. Over the next five to 10 years managers and management teams will see their bargaining power increase as retiring owners seek to exit. There are simply more baby boomers than generation Xers. A management buyout (MBO) can be a viable succession plan for businesses of all sizes.
In an MBO, the management team buys the company it works for using the security and cash flows of the company itself to obtain the capital required. Management invests its equity, akin to a down payment on a home, and borrows and/or seeks equity financing from institutional lenders and investors for the rest.
An MBO presents several advantages for the buyer: it minimizes investment risk, as the buyer has inside information on the business already, and the rates of return on equity can be far higher than those on other assets. There are additional benefits from the use of leverage, and tax advantages from owning a business. Potential buyers should have a plan to expand the business, perhaps double it in size, to make it worthwhile.
The most important advantage of an MBO is it puts the buyer in the driver’s seat. Here are six steps needed to successfully complete an MBO.
Build your management experience and credibility
Work with the owner to transition the management of the various key functions to you and/or your team. By proving you can run the company you will validate your worth to outside investors and increase your bargaining power with the vendor when it comes time to sell the company.
Position yourself
to become an owner
Building rapport and trust with the owner positions you as a front-runner to buy the business. The owner likely cares a great deal about the employees and the business’ legacy, so demonstrate that under your management the business can run independently, allowing the owner to gradually step back from the company. While you are managing the business, perform your due diligence and understand all the risks ownership will entail. Get your significant other on board, as investing considerable time and money is often a family decision.
Approach with an offer
Businesses change hands only when the owner is ready to let go. You can get a sense of the owner’s fears, motivations and concerns through open dialogue – it may be a good idea to initiate discussions with the help of a trusted outside adviser. The owner will need to feel comfortable with the deal and with ceding control, and will need to be confident that his or her next move will be fulfilling. Every situation is unique, but be prepared for challenges around seller motivation.
Negotiate from a
position of strength
The owner wants to obtain the best possible price and receive fair value for the business. The MBO will need to compete effectively with other options, such as sale to private equity or a strategic buyer. Therefore it helps if the management team is a key component of the succession plan. If your absence from the business would create a problem for a future buyer, your negotiating strength improves. This is not to say you can hold all the cards or force the owner into a decision; however, it may help in putting you into a preferred position to be chosen as the successor.
Finance the purchase
Financing for the MBO can come from a combination of conventional lending sources, subordinated debt, private investors, the vendor and your own equity. Our firm offers a management buyout package that can include loans and/or equity finance to enable management teams to buy businesses up to $20 million in value.
Close the deal
An important transaction like this requires expert advice. We recommend having a tax adviser, a corporate finance adviser and a corporate lawyer to help negotiate and structure the deal. This team will prove essential to keeping the deal on track, documenting it properly and avoiding pitfalls.
A management buyout is not for the faint of heart. But if you have dreamed of running your own show, and reaping the rewards of ownership, it could be your best chance at achieving your ambitions.
Robert Napoli ([email protected]) is vice-president of First West Capital and president of ACG British Columbia, an association dedicated to driving the growth of middle-market businesses in B.C.
