Management buyout transactions are in essence when one or more managers buy the company they work in and are a common exit strategy for owners of small businesses up to $10 million in revenue.
It may not produce the highest price the market has to offer but should bring a "fair market" price.
Advantages of MBOs are that they can be consummated relatively quickly once the right elements are in place, and they have a high success rate when approached and structured properly. Most MBOs have these characteristics in common:
1. The exiting owner sells all or most of his or her stake in the business to management.
2. The manager(s) put in their own cash.
3. There is usually some outside financing.
Exiting owners frequently pursue an MBO when they don't have children interested in or capable of owning and running the business and they are as interested in seeing their devoted employees carry on as they are in maximizing value.
Managers frequently seek an MBO because it gives them the opportunity to advance their career, control their own destiny and realize a capital gain if the buyout goes well.
In today's economic slump, the owners of companies in financial distress may want to liquidate certain assets or divest a business unit to generate cash and may be more receptive than usual to an MBO offer at this time. However, bank financing will be difficult under those circumstances.
In larger businesses, MBO opportunities often arise when ownership decides that a particular business activity is outside its core and elects to sell it off or shut it down. MBOs can also be a by-product of acquisitions.
A typical small business buyout is valued at a multiple of normalized "free cash flow," which roughly means earnings after management compensation, before interest, taxes, depreciation and amortization, less capital expenditures and working capital increases.
How much cash the manager(s) put in varies from deal to deal, but 20 percent of the total purchase price is usually the minimum needed.
Sometimes managers purchase 70 percent to 80 percent of a company now and commit to buying the remaining 20 percent to 30 percent later.
Elements of a successful MBO:
Viable business. A business needs to be producing sufficient verifiable earnings on a stand-alone basis for a third-party lender to finance an MBO. The business doesn't have to be profitable if the seller offers flexible financing terms and has faith that the managers have the know-how and reserve capital (which is rare) to mount a successful turnaround.
Quality management. In order to obtain financing for an MBO, the manager(s) must have sufficient savings and excellent personal credit.
Fair market price. The parties have to genuinely want a "win-win" outcome, or the deal will likely fail.
Seller and buyer are willing, able, informed and committed. We see too many managers waiting and hoping the owner will eventually sell to them on favorable terms, and too many owners assuming their manager(s) will be willing and able to buy on their terms when they are ready to exit.