As owners consider their succession options, one strategy is a management buyout (“MBO”), i.e., the sale of the company to the management team. There are a number of progressive indicators that a management buyout may be a viable option for the owner.
The first indicator is that the company has a strong management team that is either managing the company on a day-to-day basis or is managing an important segment of the business such as sales or manufacturing. In the case of the former, the owner may not have “formally” retired but has significantly reduced their time commitment to the company, spends a lot of time on outside interests, and is confident that whether they are at the company or not, day-to-day operations function at a high level. In the case of the latter, the management team already has day-to-day responsibility for an important segment of the business and likely has significant interaction with the other departments of the company, thereby developing a thorough understanding of the company and how to manage it under their ownership.
The second indicator is that the management team exhibits a sense of “ownership” and operates/cares for the business as if they own it.
Examples of this “ownership” include 1) always acting in the best interests of the company as if it impacts them personally, 2) pitching ideas to the owner to take the company to the next level, 3) cautiously spending money and making capital investments, and 4) being perceived by other employees as an “owner.”
The third indicator is that the management team has approached the owner and inquired about their plans for the company, has expressed an interest in acquiring the company, and has done so in a way that the owner is confident that an MBO could be successful. Over time, the inquiries may become more frequent and specific about the owner’s plans and timing.
The fourth indicator is that the management team member has indicated that they would like to assemble a team (investment banker, accountant, and attorney) to evaluate the acquisition. Management’s initiative is a strong indicator of good intentions, particularly if they are paying fees to their advisors to assist in the analysis of the opportunity.
The final indicator is that management has demonstrated to the owner that they have the personal resources or access to resources to complete a transaction. This could be demonstrated directly by management confirming their resources or indirectly based on the owner’s knowledge of management’s compensation and observation of their lifestyle and risk tolerance.
Regardless of how management’s resources are determined, the owner needs to know that management is willing to put significant capital at risk to acquire the company and not expect the owner to sell the company to them, but retain all of the risk via seller financing.
Along the way, hopefully, the owner has begun to determine the fair market value of the company, their required sale price, and potential acceptable terms. In fact, the owner could provide specific guidelines to management with respect to price, willingness to finance a portion of the purchase price, how long they would be willing to remain with the company or serve in a consulting capacity, etc. Providing these guidelines will significantly streamline the process, determine quickly if there is a basis for an MBO, and assist the owner in determining if they must pursue exit strategies other than an MBO.
It should be noted that a management buyout transaction is often considerably easier and quicker to complete than a sale to a third party buyer since management knows the business, is aware of most of the “skeletons in the closet,” and is more comfortable with many of the risks of the company, such as customer or vendor concentration, than a third party buyer.
There are risks to the MBO scenario though if a transaction is not completed with management. Specifically, if the owner changes their mind during the transaction and decides not to sell the company to management or places an unreasonably high price and terms/conditions on the transaction, then management may become frustrated, determine that the owner is not prepared to sell the company in the near future, and may ultimately leave the company for a new opportunity.
In conclusion, an MBO could be a succession option for the owner particularly if management has demonstrated many of the indicators that they are candidates to acquire the company and the owner is seeking a more streamlined and expedient path to closing than a sale to a third party.
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