Article written by Meghan Daniels of Axial
A management buyout 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 out outside financing to help fund the acquisition. Common sources of funding include seller financing, bank loans, or private equity.
Management buyouts (MBOs) can be a great option for a certain type of founder, management team, and company — but they aren’t for everyone. Middle Market Review talked to Gregg Delcourt, Senior Vice President at Alaris Royalty Corp, about what type of business tends to be a good fit for a management buyout and what companies should keep in mind before the transaction.
When do companies typically pursue management buyouts?
Usually the founder is looking to step back, but wants to make sure they’re passing the company on to a person or group of people they trust. 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. Owners may not want to deal with a third-party sale process or take a risk in terms of change of control.
What are some of the challenges of MBOs?
Historically, most businesses were just handed down to the next generation of leadership. There wasn’t the same access to capital there is today. Obviously, we’re in a world today where capital is a lot more accessible. M&A advisors on the whole are likely to advise owners to pursue a third-party sale mandate as opposed to selling to their management team. It’s a lot easier to sell to a third-party because there’s price discovery to figure out what the business is really worth.
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 his business, and an MBO will rarely provide a founder with the highest price.
That said, a sale to private equity or a strategic isn’t always in the best interest of the company or the people who got the founder to where he or she is today. Many of the companies we end up partnering with on MBOs have already initiated outside sales processes but haven’t been able to find a transaction the seller feels comfortable with.
We view an outside sales process as a positive event, as it allows the retiring founder to have the ability to thoroughly evaluate the landscape of potential options available to them. This can really help them come to a consensus partnering with Alaris to execute an MBO is the best option to achieve a fair market value for their business and ensure that the legacy of the business is protected by the management team that helped them build it.
What do you see as the most crucial factor for a successful management buyout?
It’s important that the founder, or current owner, of the business, be in a position where he or she is ready to leave. If the founder is still responsible for making significant decisions or maintaining key relationships, that will make the transaction much more difficult. One of the main benefits of a management buyout is the continuity of leadership before and after the sale — but that’s only a benefit if the founder has truly stepped back and helped diversify the company’s key relationships amongst their management team.
A lot of founders think of themselves as less important than they really are. They might say, “I’m only in the office 10 hours a week” — but those 10 hours may very well be the most critical hours of the business’ operations. The team is still looking for direction from them and they still own the majority of relationships.
If companies do have high levels of owner dependence, what can they do to make an MBO work?
We make sure that the founder is willing to stick around and continue to help transition the business after the sale. A lot of times that will mean there’s a stepped exit over time of equity. Some other groups may put together consulting agreements, but we find that typically doesn’t work as well — once someone has the money in their pocket, they inevitably become a lot less engaged than they are when they still own a piece of equity in the business. We prefer a path where the owner continues to own equity but the management can give liquidity to the owner over time.
Are there particular industries where you tend to see more management buyouts?
Often, you’ll see management buyouts in businesses that are more asset-heavy — these are companies where the management team can go to a traditional lender and borrow against their assets and buy out the founder that way. However, MBOs certainly aren’t limited to these businesses. Our mandate focuses on asset-light businesses; we’re looking for companies that are more service-oriented and less asset-intensive. MBOs also tend to work well for these businesses because they ensure that their customer relationships — on which they are dependent — won’t be disrupted post transaction.
What’s an example of a business Alaris recently partnered with on an MBO?
We recently partnered with Heritage Restoration, a specialty contractor based in Boston. The current CEO had been with the company for 14 years, and during that time the founder had slowly transitioned out. He was ready to sell the business. He first went out to market to see if he could find an outside buyer, but then they came across the Alaris Preferred MBO structure and realized it might be a good fit. We were able to help the CEO fund the acquisition of the business from the founder through our preferred equity investment. The CEO ended up owning all the equity as the founder shares were retired.
In general, Alaris’ model is different from that of a typical private equity firm, which has to provide liquidity back to their LPs. We’re a public company, so our capital is effectively evergreen. We take a preferred equity distribution. We don’t have a time horizon — we’re in it for as long as the new owners want us as partners.
When the Alaris Preferred MBO is said and done, the management team owns 100% of the company. The day after close, our goal is to see the business continue to operate just like it did the day before. We’re not there to tell them when to spend a dollar and when not to spend a dollar, but we can provide guidance or counsel with regard to strategy, acquisitions, and other key decisions in the business.
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