Management Buyouts and Buyins

Are you thinking whether or not you should raise capital or sell your company or in 2010?

ClearRidge Management Buyouts
Tulsa Oklahoma

Now, more than ever, you need to consider all your options. Most business owners typically see two options when it comes time to raise new equity or sell their company: 1) strategic buyer or 2) financial buyer. In reality, you have many more options open to you.

In fact, an outright sale rarely yields the highest price, so consider these 9 alternatives before making up your mind:
i) sell to employees;
ii) take the company public
iii) sell to family members;
iv) sell to co-owners;
v) sell through a charitable trust;
vi) sell majority interest and immediately exit the business;
vii) sell minority interest to new investors and use their capital to grow the business;
viii) enter a joint venture to test the water with a possible acquirer;
ix) merge your business with another company.

The important point here is that there are many options available and it makes sense to work through the merits, advantages, challenges and tax implications of each one before starting down the road.

How about a Deal with Management?

Today, we are going to discuss one of the more favorable options in this climate: Management Buyouts (MBOs) and Management Buyins (MBIs). Over the last few months, MBOs and MBIs have become increasingly popular for a variety of reasons.

The first thing to do is assess the likely value that the transfer could bring. In a 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 to sell for the highest price and realize the most value.

Transfer Ownership to Managers

Management transfers (buyouts and buyins) typically occur when: i) the owner of a privately-held company decides to sell; or ii) a larger company sells off a division; or iii) a bankruptcy forces liquidation of a failed business.

Differences between an MBO and MBI

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.

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.

Investor and Deal Structures

MBOs and MBIs 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:

An MBO will likely have a more efficient and cooperative due diligence process. Management knows the business intimately and may even know more about the business than the 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.

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 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 advisors from a specialist M&A 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 ClearRidge would welcome the opportunity to represent you in your management buyout.

Difficulties to overcome for Management:

Time view of investors vs. managers: 5 years for equity sponsors vs. 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 be comfortable that they will support the transaction. Management need to determine if the new capital structure will allow sufficient runway for the newly acquired company to succeed.

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 ClearRidge to arrange a no-cost consultation to discuss how a management buyout could work for your Company.

This is our last newsletter before the holidays and we would like to wish you and your family a Merry Christmas and a Peaceful and Prosperous New Year.

All rights reserved. Copyright: ClearRidge Capital, LLC, 2009.

ClearRidge Management Buyouts
Tulsa Oklahoma

About ClearRidge Capital
ClearRidge Maximizes Enterprise Value as a business, financial and strategic advisor to midsized US companies. ClearRidge’s Directors have completed over 200 MandA transactions, provided restructuring advice and secured new and replacement debt and equity for companies across the US and Canada.

Mergers and Acquisitions includes buying, selling, merging and valuing midsize companies. Restructuring includes financial, operational and strategic restructuring. Corporate Finance includes advisory for raising and replacing debt and equity to provide the lowest cost of capital. Turnaround, Bankruptcy and Crisis Management services include debtor and creditor advisory, bankruptcy support and turnaround management. We provide top tier advice and relationships with Middle America values.

For further information, visit www.clearridgecapital.com.