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Six steps to completing a management buyout

Buying and owning your own business can be the most rewarding investment you make if executed properly. 

A management buyout (MBO) is when a management team seeks to buy the company they work for from the current owner using the security and cash flows of the company itself to obtain the capital required. Management invests their equity, akin to a down payment on a home, and borrows and/or seeks equity financing from institutional lenders and investors for the remainder.

Over the next decade, managers and management teams will see their bargaining power increase as retiring baby boomers seek to exit. MBO’s present several wins for the potential buyer; it minimizes investment risk, as you have inside information on the business already, and the rates of return on equity can be far higher than other assets. There are additional benefits from the use of leverage and tax advantages from owning a business.

However, the road to becoming a business owner can also be challenging, including negotiations with the seller, structuring your offer and securing financing. But with the right action plan and professional advice, you can make entrepreneurship a reality.

The most important advantage of an MBO is that it puts you in the drivers’ seat. Here are six tips from First West Capital on completing a management buyout:

1. Build your management experience and credibility

Work with the owner to transition the management of various key functions to you and/or your team. By proving you can run the company you will validate your worth to outside investors and increase your bargaining power with the vendor when it comes time to sell the company.

2. Position yourself to become an owner

Building rapport and trust with the owner positions you as a front runner buyer. Be upfront about your aspiration to own the business; this ensures there are no surprises when you approach an offer down the road.

The owner likely cares a great deal about the business’ legacy and its employees, so demonstrate your management capabilities; let them know that under your management the business can run independently, allowing the owner to gradually step back and find new purposes in life that pull them in a new direction. While you are managing the business, do your due diligence and understand all the risks ownership will entail. If you have a significant other, get them on board, as investing considerable time and money is often a family decision.

3. Approach an offer

There is a lot that goes into structuring a potential offer, so do your research and seek trusted business advisors. The owner will need to feel comfortable they are getting the right deal, be okay ceding control, and be confident their next move will be fulfilling. It is always a good idea to dig deeper through open dialogue. If you have positioned yourself well, you may already have a sense of the owner’s fears, motivations and concerns. Businesses only ever change hands when the owner is ready to let go. Every situation is unique but be prepared for challenges around seller motivation

4. Negotiate from a position of strength

The owner wants to obtain the best possible price and receive fair value for the business. The MBO will need to compete effectively with other options, such as sale to private equity or a strategic buyer – therefore it helps if the management team is a key component of the succession plan. If your absence from the business would create a problem from the future buyer, your negotiating strength improves. This is not to say you can hold all the cards or force the owner into a decision, however it may help in putting you into a preferred position to be chosen as the successor.

5. Finance the purchase

Financing for the MBO can come from a combination of conventional lending sources, such as a business loan from your bank, subordinated debt, private investors, the vendor and your own equity. At First West Capital we offer junior capital – sub-debt, mezzanine and minority equity financing – to maximize flexibility and minimize dilution of your equity.

We look for management to invest a meaningful amount of equity, relative to their personal net worth, and we provide financing for the rest. We help management achieve 100% ownership over time by providing an option to buy us out. Our partner-focused approach helps us leverage flexibility and eliminate financial hurdles.

6. Close the deal

A transaction like this requires expert advice. We recommend having a tax advisor, a corporate finance advisor and a corporate lawyer to help negotiate and structure the deal. This team will prove essential to keeping the deal on track, documenting it properly and avoiding pitfalls.

Owning your own business gives you control over your future; but a management buyout is not for the faint of heart. But if you have aspired to run your own show, and reap the rewards of ownership, it could be your best chance at achieving your ambitions. Combine the right amount of grit and some expert advice and you can make it possible.

This article has been modified from its original version which first appeared in Business in Vancouver in 2017.