Business Succession: Is an MBO or Employee Share Ownership Plan Right for You?
You've trained good people to do good work — let them take over your business when it's time to retire. This is how.
Many businesses with the right ingredients do not think they can raise the money — but there are many options available.
Employee ownership can be a great way to pass a business on to the next generation that ensures local ownership continues and jobs stay in our communities. It is also a viable solution for business owners looking to retire while at the same time ensuring their legacy continues.
Unfortunately, it is often overlooked as a succession strategy. This article discusses what it takes to complete a successful management or employee buyout.
An employee or management buyout is the acquisition of all or a majority of the business owner’s shares in the company by the employees. The transfer can be done over time or all at once, with the end goal of transferring a controlling interest to the new owners. Contrast this with an employee share ownership program, or ESOP, which is typically structured to allow employees to buy a limited number of shares to increase their ties to the company.
The Management Buyout Approach
Management buyouts can be used for small businesses all the way up to middle market companies with hundreds of employees. Most commonly, First West Capital has helped finance the purchase of companies with 20-100 employees. In just about all of these transactions, the companies not only survived, they thrived. One of the keys to success is having a great management team. We look for employees who have worked at the company for a number of years and who, as a team, have experience running all the key management functions. These include sales, client service, production, engineering, IT and finance.
The retiring owner must delegate management responsibilities in a phased approach and be willing to let go. The management team needs to have demonstrated real leadership abilities.
Owners Have to Help Themselves to Help Their Staff
Tetrad Computer Applications, a Vancouver company that provides geographic and demographic market analysis solutions, completed a successful employee buyout in 2012. The president, Michael Simon, and three other managers who bought the company have gone on to double the size of the business.
Simon’s advice to budding entrepreneurs is to focus on the business basics. “After closing the MBO, you have to transition quickly from the excitement of working on the deal to running the business. Don’t think about the debt-load, just get moving and make the moves that you intuitively know are best for growth. We kept things simple and focused on profitability.”
I watched the Tetrad management team pay attention to every detail, from when to hire to reducing their rent costs. They also unleashed pent up ideas on how to add value for their customers, which brought in new business and added to their profitability.
Simon’s advice is to clearly delineate between one’s ownership and employment role. “A common mistake is confusing your ownership position in the company with your operational role in the business. Avoid this by establishing a clear understanding of the leadership structure and discuss how each owner will participate in future profits. This is critical to the long-term health of the company and partnership.”
Other Financing Options
Many companies have all these ingredients for success, but still an employee buyout is not considered because they do not think they can raise the money.
Depending on what the company is worth, there are numerous options available for financing. These include senior debt, mezzanine financing and equity. Good advisers can direct you to the right sources and steer you through the process.
These financing solutions enable employees or management to buy the business even if they do not have a lot of money. Of course, those serious about buying the business must put their skin in the game — an amount that is meaningful for them and their families to ensure commitment and alignment.
Big Business, Big Buyout — How Can My Staff Afford It?
For larger deals where an equity partner is needed, your employees or management can negotiate long-term incentive programs, often called earn-ups, to allow them to earn additional equity if they hit defined performance benchmarks. After five or six years, if everything goes well, they can buyout the business and achieve 100% ownership.
Simon’s team have now paid off all their financing and own the business outright. What this demonstrates is that employee share ownership can align the interests of owners and management and unleash creative energy to grow companies and jobs.
Business owners contemplating retirement should consider the option as a way to ensure their company continues to thrive in the future.
Written by Robert Napoli