Management & Employee Buyouts
Many compassionate business owners seek to reward their managers and/or employees’ long service and loyalty by giving them the opportunity to buy their company. In select situations, employees can be ideal buyers, and even pay a premium for the company.
More commonly, however, a sale to a management and/ or employee team would be disastrous, as many such teams lack the financial resources, management and leadership skills, and risk taking characteristics required for successful business ownership. In addition, employees often feel they are entitled to purchase the business at a substantial discount, to compensate them for their years of service helping to build the company (notwithstanding compensation already received for doing so).
Sale to management or employee groups is fraught with risk and complexity. It is not uncommon for business owners contemplating this option to grossly underestimate the challenges involved. They reason “I have the buyers and the buyers know the business. It should be a piece of cake”.
But there are unique and daunting issues to be addressed in a buyout, including:
- · Assessing the management team’s capability to purchase and manage the company. As any business owner knows, a strong desire for ownership is necessary but not sufficient for success. The team needs to have strong leadership abilities, financial resources, and risk tolerance.
- · Reaching agreement on valuation.
- · Developing consensus on division of responsibilities and percentage ownership. The resources available to invest in a purchase inevitably will vary dramatic among employees, as will their management capabilities. The situation is ripe for resentments and disputes to emerge among employees, which can kill any potential deal and lead to a loss of key people.
- · Maintaining confidentiality. As the number of people involved in a potential purchase increases, the risk of the word getting out to customers, suppliers, and other stakeholders increases exponentially.
- · Obtaining financing and structuring the deal. Management and employee teams are typically able to come up with only a small percentage of the purchase price. Aggressive lenders need to be found who are willing to take takes on team that hasn’t proven it can succeed without the owner. The vast majority of lenders shy away from these transactions, but we have relationships with firms that make such deals a core part of their business. Frequently, the selling shareholders will need to receive much of their compensation in notes and/or “earn outs”. These payments need to be structured in such a way as to reward the seller for the added risk taken, but not excessively burden the management team with unmanageable debt.
- · Ensuring the new owners are positioned for success. Gaps in the acquiring team’s leadership and management skills need to be rigorously and honestly assessed, and plans developed to mitigate. Representative options include the seller staying on in a consulting or transitional role, hiring consultants or part time employees to fill the gaps or divvying up the seller’s responsibilities among several managers with the right mix of talents.
- CDC can help clients assess the viability of the management/ employee buyout option, and if appropriate, structure and negotiate a win/win agreement. We can represent the owner or the management team.
While the challenges of a management buyout are substantial, the rewards for both owners and employees of a successful deal can be exceptional, and this option deserves consideration by many potential sellers.