As an integral part of any well-prepared equity divestiture strategy, you should explore and vet out each of your available exit channels. Doing so allows you to select the most effective and efficient path to achieve all your ownership goals (personal, family, business and financial). Ideally, before fully vetting any exit channel, you should be prepared personally, your company should be running at peak performance and the markets should be favorable for a transition.
The typical exit channels available to closely-held business owners consist of external and internal channels. Primarily, these are broken down as follows:
- External channels: strategic buyers and financial buyers; and
- Internal channels: co-owners, management buy-outs and buy-ins (MBOs), employees through ESOPs, family and debt recapitalizations.
The focus of this piece is to provide an overview of the management exit channel and offer a framework to help you begin exploring this option in concert with your other channel options.
Management Channel Expectations
To begin, it is important to review the typical pros and cons of using your management as a means to exit. It is especially important in this case to review the cons, as they often deter owners who may have other exit channel options.
Here are the pros of doing an MBO:
- Provides you greater control of your legacy as the underlying company is normally maintained in the same community with the same company name and the same employees;
- Reduced due diligence time and costs as your management team already knows your company intimately;
- No sales and marketing costs as compared to selling to external parties; and
- More control and flexibility in how you transition - opportunity to exit your ownership and your management role in either one event or over time.
And here are the cons of doing an MBO:
- Limited financial resources and, thus, a material amount of seller financing is often required;
- Doesn’t offer the highest available market price - strategic buyers typically can justify the highest price due to synergies which aren’t available to other buyers; and
- Highly sensitive and risky channel to fully evaluate (listen here to our podcast discussing this key issue).
Step 1 - Is the Management Channel Accessible?
Consistent with evaluating any potential exit channel, you first must assess if your company’s profile permits using this exit channel. Accordingly, the first step is to gauge if your current management team can not only run your company in your absence, but if they can grow it and be successful long-term without you. Are your key managers all 9s and 10s?
As you consider this, think about your current strengths and the most important roles you play within your company. Can you transition your roles to the current management team? If not, can you accomplish this transition with a new management structure; groom or hire the missing aspects; entice externally the ideal successor with an ownership opportunity; and do all of this within a reasonable time frame? If the answer is "no" to these questions, then this exit channel is not available to you. If the underlying philosophy is that if you don’t have a strong management team, then the stakeholders of the company (lenders, employees, customers, vendors, etc) won’t have confidence, and monetizing full company value won’t occur since the risks to pursue an MBO will be too high.
If the answer is "yes," then you need to do a self-evaluation: are you willing to transition total control to your management team? This would include transitioning all the financial decisions, key customer and financial relationships, sharing all trade secrets or other knowledge critical to the company's success, etc. Unless your successor ultimately receives all the knowledge and power that you currently hold and enjoy, they will inevitably struggle.
Note: Irrespective of when you exit or which exit channel you ultimately choose, having a strong management team should be a top objective for an owner as it creates value now and in the future. Most buyers rank a seller’s management team as one of the top factors in evaluating potential acquisitions.
Step 2 - Evaluating if the Management Channel is Available
If you have determined the management exit channel is accessible, step two is identifying the most crucial member or members of the management team. These are the managers whose participation is absolutely crucial to the success of the management buy-out or buy-in. Once identified, then you need to discover if these members have the desire and motivation.
This is a delicate area as attention to your eventual departure can create uncertainty and insecurity, especially if the managers don’t have a desire to purchase or want to purchase, but you ultimately choose another exit channel. If you have strong relationships with your team, then, typically, you will have a sense of their desire already. To mitigate this risk and to provide you the greatest leverage, you should already understand your alternative exit channel options.
In addition, you should tactically position the purpose of the management conversations. For example: you would like to take time off and are considering transitioning to an absentee owner, or would be willing to explore selling some or all of your equity interest to them if they are interested. Obviously, confidentiality and trust is crucial. Accordingly, you would want to have everyone sign a confidentiality agreement, non-solicitation, and/or non-compete prior to initiating any formal conversations.
Step 3 - Fully Vetting the Management Channel
If your management team expresses a strong interest and before launching into the quantitative aspects of the deal (price, structure and terms), you should first vet the qualitative aspects to ensure all parties are aligned before discussions continue. Such qualitative aspects would include: the company vision, growth opportunities, risks, organizational structure, which management members to include, timing and length of transition, etc.
A common benefit of first agreeing on the qualitative aspects of the company is that it can frame up the underlying financial outlook of the company, which provides the foundation for agreeing on value and expedites negotiations. Remember, seller financing is a common necessity with this exit channel, so be prepared to explore the various structure options that provide you with the best fit and least risk. The key is that the management team puts meaningful financial "skin in the game" to acquire ownership (including being prepared to sign any personal bank or creditor guarantees). If they don’t, they aren’t fully committed.
If you reach an impasse in negotiations, try to table this channel and use it as a fallback and quickly proceed on to your other options.
So What Does This All Mean?
The management exit channel can be the right fit and a satisfying channel for only certain owners: those that have price and terms flexibility to meet their long-term personal financial needs and strong legacy goals. Just be aware that this channel is loaded with risks that you must evaluate first. You should have a well thought out plan prior to embarking in order to mitigate these risks and retain value.
For owners who have limited channel options due to lack of planning, personal timing or company condition, the management exit channel can often be the only viable one. If this is the case, you may be in a precarious position and would be well served developing a detailed plan with added flexibility, and a focus on mitigating the risk factors in order to retain and monetize the greatest value.