How to Plan for a Management Buyout: Tips for Successful Business Owners
Many entrepreneurs dream of growing their business and taking it to the next level. After all, that’s what motivates people to start businesses in the first place. However, transitioning from owner-operator to business owner or managing director can be a scary and challenging process. Luckily, there are several things you can do in advance to help ease some of the stress and anxiety so you’re more prepared when the time comes. A management buyout (MBO) is a strategic financial transaction that aims to acquire control of your business from you as a sole and current owner through a financing agreement with your board of directors. If you’re ready to step away from running the day-to-day operations of your company, and instead focus on growing your capital into something bigger and better, then read on! You may even be surprised to learn just how much MBOs can help you grow your business or consolidate operations into one organization.
What is a Management Buyout?
A management buyout (MBO) is a financial transaction that aims to acquire control of your business from you as a sole owner through an agreement with your board of directors. It’s a strategic financial transaction that can serve many purposes, including:
â— Providing a cash infusion to accelerate growth and bring about a new era of success for your company.
â— Experimenting with new leadership models that can help you identify and cultivate future leaders of the management team.
â— Alleviating debt or financial pressure on your company by distributing ownership of the business among existing shareholders.
â— Extend your time in the business world by acquiring control of your company for a limited time before passing the reins over to someone else as manager.
â— Acquiring control of your business without taking on all the financial risks of debt and responsibilities of owning a business.
Why Conduct an Management Buyout?
There are many reasons you might want to consider conducting an MBO. The most common reasons include the following:
â— Exiting your company by selling it to another company or individual. An MBO can provide you with the cash flow you need to conduct due diligence on potential buyers. It can also provide you with immediate liquidity to sell your company if you discover another buyer or opportunity.
â— Increasing the value of your company. You might conduct an MBO to raise additional financing, to acquire another company, or to pursue an acquisition strategy.
â— Demonstrating strategic clarity and vision. Conducting an MBO might be the best course of action to show your investors, lenders, and the financing community that you have a clear vision for your business and are willing to take bold steps toward making it a success.
â— Reducing your ownership stake in the company. If your company is valued too high relative to your ownership stake, you might want to consider selling it to someone else through an MBO.
â— Maximizing tax benefits. A management buyout may be the best way to maximize tax benefits such as the Section 77 deduction, which allows businesses to expense the cost of certain assets over the course of the year.
â— Conducting an MBO transaction to bring new management team members or an outside owner into the fold.
â— Conducting a management buyout to find a financial partner to help you grow or acquire your company.
Key Terms You’ll Need to Know
â— Board of directors – The group of people appointed to serve as the fiduciary agents of the company, with authority for asset management, financing, and conducting business operations on behalf of the company.
â— Buy-sell – The sale of stock by an existing owner to purchase public or private equity in another company.
â— Buy-sell agreement – The formal arrangement between the owner and the management team that sets forth the terms by which the management team will be compensated if the owner chooses to sell the company.
â— Buy-sell back(1) – The agreement between two companies that allows one company to buy back shares from the other company at a price determined by the management team.
â— Buy-sell back(2) – A variation of a buy-sell back in which another company acquires the first company.
â— Company – The legal entity that owns the assets of the business.
â— Equity – Money previously invested in a business, usually as stocks or shares of ownership. Public equity is a share in a publicly traded company. Private equity is a share in a company that is not publicly traded.
â— Leveraged Buyout – A leveraged buyout (or leveraged management buyout) occurs when one company negotiates the process of acquiring another using mostly borrowed funds. The purpose may be to take the company private or to spin off part of the business.
â— Management team – The management team is the current group of people who are responsible for running the company.
â— Proxy – A proxy is a written authorization that a shareholder can use to cast a vote for a particular choice in a company’s existing management.
â— Section 77 – A deduction allowing for the expensing or financing of certain assets bought for business use over a certain period.
â— Stock – Ownership interests in a company that give investors the right to receive dividends, share votes, and participate in company decisions.
â— Voting rights – The ability of a shareholder to cast a vote for the company’s existing management team.
Benefits of a Management Buyout for the Company and the Owner
1. One of the main benefits of an MBO is that it preserves value for current shareholders by affording them immediate liquidity and providing them with a share of the upside if the business succeeds.
2. Many owners sell their company to bring stakes of the ownership to management teams.
3. A key benefit of an MBO transaction is that, if the business succeeds, it provides the existing shareholders with access to funding.
4. Finally, an MBO lets the current management team acquire ownership in the business, subject to certain exceptions.
Securing Financial Advice and Professional Help with a Management Buyout
Having a sound and comprehensive financial plan can help you make informed decisions, but it’s important to remember that you can’t make solid business decisions without good business sense. This means you’ll need to get some financial planning advice to help you make the best choices for your company. You’ll also want to ensure you have the right professional assistance on your side. You’ll want to work with professional advisors who are experienced with managing MBOs, and experienced with helping businesses transition to a new ownership structure and management team. The appropriate professional advice and support will prevent you from becoming overwhelmed or discouraged.
How to Conduct an MBO
There are many things to consider before initiating an MBO. First and foremost, you should decide if you truly want to take this route. There are a lot of risks and challenges to conducting an MBO. The better prepared you are for this process, the more likely you are to find success. It’s important to get professional financial and legal advice to make certain that the process goes as smoothly as possible. Next, determine how much cash flow you’d like to raise, and have a plan to acquire that money. Consider conducting an MBO as part of a financial restructuring or as a sale of your company. The choice will likely be determined by the amount of money youâ€™d like to raise.
Things to Consider When Executing Management Buyouts
As with any major business decision, you’ll want to approach a buyout in your company with extreme care and thoughtfulness. First, you’ll want to assess the deal’s financial modeling and feasibility based on the value of your company and the value of the prospective buyer. That will determine the price you’re
willing to accept for your company. Next, you’ll want to evaluate the terms of the deal based on your personal preferences, your company’s needs, and the buyer’s needs. For example, you may want a majority of the board of directors or the existing management teams to stay in place, while the buyer may prefer to have all hands on deck. Once you’ve gathered all this information, you can begin reaching out to potential buyers and negotiating the terms of the deal.
The Negotiations Before the Closing
Most MBOs involve extensive negotiations before the closing. There are a few reasons for this, and it’s important to understand them before you make any decisions about how to approach negotiations. First, the buyer may want to negotiate the price of the acquisition down from the original asking price. Second, the seller may want to negotiate the price up from the price already negotiated. Third, both sides may want to renegotiate various terms, such as the amount of equity each side is getting, the method of acquiring public or private equity, the length of the acquisition, and even the terms of the transaction itself.
Final Words: Is a Management Buyout Right for You?
The best way to see if an MBO is right for your company is to try it out. That means approaching management buyouts as a test case, not a permanent change to your business model. That means you’ll want to do everything you’d do under normal circumstances, but you’ll also want to evaluate the experience as a trial run. For example, you may want to keep a running scorecard of how things are going and ask your advisors and accountant for feedback on the process. Remember, however, that an MBO is not a permanent change. It’s simply an approach to seeing whether management buyouts are desirable for your company. Once you’ve gathered all this information, you can decide whether an MBO is appropriate for your company and you.