Is an Individual or Management Team Buyout Right?

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This had come up recently in a couple of my transactions, and I also had a similar experience in selling one of my companies. Therefore, I thought it would be worth writing about the potential of management or individual buyouts, since it does come with a few challenges.

A management buyout (MBO) is exactly what it sounds like — a management team (or individual) purchasing the business they’ve been running.  The management team may use personal resources or seek outside financing to help fund the acquisition. Common sources of funding include seller financing, bank loans, and funds from friends or family (or maybe even private equity).

Many times, owners don’t want to look to the outside to sell their company or they have been approached by employees to purchase the company. Usually, the team can sense when the founder is looking to step back and knows that they want to pass the company on to a person or group of people they trust; therefore, a management team buyout makes perfect sense.  Like any seller, owners interested in MBOs are looking for liquidity. But they tend to be equally, if not more, interested in their legacy and the impact of a potential sale on the company, employees, and surrounding community. Therefore, this type of buyout can be very appealing. 

But what if this option doesn’t net enough proceeds, or what if the founder doesn’t believe the team can handle the company afterwards; then what?

Challenges of “potential” MBOs

There can be many challenges, but let me address two main ones. First, in an MBO, there’s always the question of whether the founder is being taken advantage of or leaving money on the table. Even the founder who really likes his management team still wants to make a good rate of return on the sale of their business, and an MBO will rarely provide a founder with the highest price. 

The second challenge an owner faces is determining if the individual or management team is truly capable of running the company post-acquisition and after the owner leaves. That’s a harder conversation to have and one which most owners want to avoid.  In an all-cash situation, that is less of a concern because, as my husband likes to say, “You can take the money and run,” (he even made up an acronym for that: “TATMAR”).  But most deals aren’t structured that way, and instead include some form of seller financing over an extended period of time. And even with seller financing, if the company doesn’t do well, then the note will likely not be paid.

How do you overcome these two major challenges?

I always suggest taking the company to market to find out what the company is truly worth. While this can be a time-consuming event, it does allow the retiring founder to thoroughly evaluate the landscape of potential options available to them. It also takes off the table the difficult discussion of value.  If the founder is presented with one or two external offers, this then provides a basis for what the company is worth.  Sure, the founder can always discount that if needed, but it does allow for all parties to see the worth of the company. 

This external validation, however, may have to be done very discretely as to not ruffle feathers internally. Especially if the owner isn’t sure that the team or individuals will offer up a fair price. If the management team is already prepared to make an offer, then this can be done with more transparency. But regardless, the management team may not be in favor of this approach as it will most likely drive up the price. 

The second challenge can be difficult to overcome as well, but can potentially be solved in the same way as the first one.  Often when founders want to leave entirely, this appeals to a certain type of buyer that likes to come in and take over as an “owner/operator.”  These individuals typically have experience in the industry, either with a former PE firm or in the capacity of running a similar but much larger company.  While they may not have the experience running your company that your team has, they do come in with a fresh view and new ideas, which can help accelerate growth. Or you may attract a much larger strategic buyer who can bring lots of management to the table and will provide the individual or existing management team much more growth and opportunity than they would on their own. 

My own experiences with potential MBOs

I had two situations where I had buyers, both internally, who wanted to be able to bid on my company when I decided to sell.  In both cases, while I did feel that they could run the company after I departed, I didn’t feel like either party would necessarily offer me market price. Therefore, I did go to market, and once I found my first potential buyer and negotiated the price I wanted, I went back to these buyers and presented them with those offers.  One backed down quickly as it was more than they would offer. In the second instance, the individual was interested, but needed time to raise the funds, which also posed a problem for me as I had a time limit on the external offer I was presented. 

I did try to stall my prospective buyer as much as possible, but in the end, the individual couldn’t come up with the financing on a timely basis. However, in both cases, I didn’t let the prospective buyer know that my management team or an individual on my team was also considering an offer.

I did this for two reasons: first, I didn’t want the prospective buyer to think that there would be conflicts within the team; and secondly, because I knew that if the individual wasn’t able to come up with the financing, they would still want to remain. That may not always be the case, though, and can create some issues internally. 

In the end, only you can assess how your management team will react to an external buyer. It does need to be handled delicately and with care, though, as to not ruffle feathers.  If you do end up choosing an external offer over an internal one, I highly recommend that you provide opportunities for your internal team to profit from the company sale, and ensure that they are also compensated on future earnouts and equity.  More on that in my next post: How to Compensate Your Internal Team When You Sell Out.