Management Buy Outs or MBOs
Your core management team was likely instrumental to building your successful business enterprise - and it may seem natural that they should be the ones most likely to succeed you on your business exit. Without preparation and foresight, however, the transfer of power, and company value, to a member or members of your management team can be a difficult and jarring experience for all involved.
When considering a business transfer to key employees or a management group, an exiting owner must explore his or her personal needs to ensure that it is a solution appropriate for his situation. An owner must be aware that management buyouts will likely result in significantly less cash at closing to the owner, who often holds the majority of the stock, and risk, of the business while the buyers make structured payments on the principal plus interest over time. Without a financial backer behind the transaction, the business’ existing assets may need to be used as collateral for a loan toward the initial down-payment to the exiting owner, who will also accept deferred payments when the business produces future profits. An owner must therefore have a high financial, and relatively low mental readiness (i.e. long time horizon) to leave the business to strongly consider a gradual management buyout. The majority of one’s business wealth remains locked in this scenario, still at risk while under new management. Due to this, the owner will often remain in a managerial role in these situations, making a management buyout a potentially attractive proposition for owners with a moderate or low mental readiness to exit.
Many business owners, however, underestimate their personal ties to the business. On seeing changes, minute or drastic, to what had been their business, it is natural to feel slighted and to potentially regret transferring the business. If the owner has remained in a key role and/ or maintains a majority share of the business, conflicts could erupt, eventually leading to a failed exit and a weakened business.
It’s a Matter of Perspective
Prior to that point, it is important for an owner to consider the possibility of difficult negotiations with key employees, which may also impact business relations and the owner’s personal net worth. The owner’s value of the business may differ significantly from that of the prospective management team, and it is also important to acknowledge that not every employee is meant to, or desires to, be an entrepreneur.
Generally, the positives of an internal transfer can outweigh the negatives for an exiting owner comfortable with the management team taking over. Structuring an internal transaction as such can allow the exiting owner more control over the transaction and the time-frame of the takeover, as well as ensuring that company shares go to the intended beneficiaries in as tax-efficient a manner as possible. This internal structuring is not ideal for each exiting owner, however, as the valuation of the business is typically lower than it would be in an external transfer, and the owner’s decreased payout will still be dependent upon the future success of the business, which he or she no longer controls.
Management buyouts are technically deemed internal transactions, but are not subject to the fair market value standard as are gifting transfers of ownership. In a cross with external transfers in this way, management buyouts require the managers to act as the “market” in determining a value for the business representative of their expected returns on the investment.
An owner must consider his or her financial and emotional readiness prior to contemplating all exit options, including management buyouts. Management buyouts offer strong pros and cons for the exiting owner and his heirs, depending greatly upon the owner’s ability to achieve financial goals without solid income from the proceeds of the business sale. This is a very conservative, but realistic approach. The owner often will be asked to stay on for a pre-determined period of time to assist in the business transfer, and additional bonuses or incentives may be provided in return for investments returns.
An MBO permits the owner a level of flexibility not available in most alternative exit options, allowing him or her to set responsibilities and guidelines gradually over time to ensure the transfer is a good fit for all, and for the owner to mentally prepare for the business exit.
At the end of the day, an MBO may be an exiting owner’s best or only option. Therefore, proper planning and a timed and strategic exit is recommended - Leave the proper amount of time to carefully address the effectiveness of this option for your business exit.
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Management Buy Outs
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