Leveraged & Management Buyout Financing
Debtsrestructuring.com has extensive experience with management buyouts. In a business climate where the majority of midsized companies have seen revenues and earnings fall in the last 18 months, a transfer to management can be the best way for an owner to sell and management to invest in the future growth of the company.
Deal Structures
Management buyouts are often backed by private equity investors and are typically structured either as an Equity sponsored buyout or a Leveraged buyout:
1) Equity-sponsored buyout (ESB). In the current climate, equity-sponsored buyouts typically consist of 2%-10% management equity, 40%-50% private equity capital and 40%-60% bank or asset-based lending. So, in effect, majority equity ownership is taken up by the private equity sponsor, with debt funding about half of the proceeds to the Seller. It is possible that equity sponsors may also require up to 10% in a Seller note.
Management may contribute a token investment of equity and earn additional equity interest based on company performance, as well as the right to acquire further equity pari-passu to the equity sponsor’s contribution.
2) Leveraged buyout (LBO). In the free-wheeling, easy credit days (pre-2008), many management buyouts were structured through a leveraged buyout. A LBO would typically consist of 5%-15% management equity, 10%-25% seller note, 5%-20% mezzanine capital and 40%-60% bank or asset-based lending. So, in effect, it would be seller debt, mezzanine debt and bank debt that funds the acquisition.
In the near term, it is unlikely that a LBO will be used to fund a management buyout. Not only is there a higher failure rate than with an ESB, but it would also be difficult to secure the financing with so much leverage.
Advantages of an MBO for Seller:
Management’s desire to have skin in the game shows their confidence in the Company’s future, which in turn increases investor confidence in the deal. Higher confidence and less perceived risk may allow a higher sale price.
An MBO will likely have a more efficient and cooperative due diligence process as management already knows the business intimately.
Difficulties to overcome for Seller:
There is an inherent conflict of interest in a MBO. Management is in a position to reduce the sale price or block competitive offers leading up to the sale. Management may also not agree to stay if a competing offer is accepted.
The Seller may have less information about the business and less leverage in negotiations & Valuation because of the management’s role in the business.
Timing is critical. At the closing table, there could be management, private equity, a bank, mezzanine lender and the seller all having to sign off on the deal at the same time. Each group has their own agenda and is represented by different counsel. It is a real challenge to accommodate each party’s needs in a timely and professional manner. From the outset, a MBO should be a well planned and carefully orchestrated effort to get the deal closed and each party needs to enter the process with a willing attitude to make some compromises to get the deal done.
Hiring Lawyers or advisors from a specialist M&A (mergers and acquisitions) firm who have extensive MBO experience will increase the odds of getting a deal done, as well as help to satisfy the needs of all parties and smooth negotiations. Our team at Debtsrestructuring.com would welcome the opportunity to represent you in your management buyout.
Difficulties to overcome for Management:
Time view of investors vs. managers. A typical investor will look to sell again in 5 years versus possibly 10 to 15 years for managers. Management and equity sponsors need to resolve these differences early in the process.
Investors want the company to be run to maximize returns within a short time-frame. Managers may have alternative ideas about long-term appreciation of the Company. There needs to be a common agreement and clear plan agreed between managers and equity sponsors before entering an agreement.
Managers need to understand the implications of the new capital structure and determine if the new structure will allow sufficient runway for the newly acquired company to succeed.
Will an MBO or MBI work for your company?
Below is an outline of the characteristics that would typically favor a MBO or MBI.
Industries
Management deals often occur in mature industries that require low levels of capital investment. Ideally the company would have a loyal customer base. Non-cyclical businesses with reasonable to high margins are favored.
Management Team
Management experience, track record and credibility are paramount. Time and again it is proven that investors back a management team above most everything else. Management needs to have some skin in the game and should be able to raise their own funds or pledge assets. To avoid future headaches, you should only involve managers who are critical to the success of the business. The fewer the better.
Company
The Company should have predictable and stable cash flows with profit margins above industry averages. Financial reporting should be process driven, clear and efficient. Proprietary or defensible products and services are preferred.
Differences between a Management Buyout and Management Buyin
Management buyouts occur when existing management of a company acquire majority ownership from the owners.
Management buyins take place when external financial investors back an outside manager/operator with key industry knowledge and experience to lead and grow the company.
Now, more than ever, you need to consider all your options. It makes sense to work through the merits, advantages, challenges and tax implications of all your options before starting down the road.
This brief overview of management buyouts only scratches the surface of everything you are likely to encounter. If you would like to dig deeper, you can call our team at Debtsrestructuring.com to arrange a no-cost consultation to discuss how a management buyout could work for your Company.