How to structure the offer of a Management Buy Out
A hardworking, smart professional presented me with a scenario on an offer she had received to conclude a management buy-out.
She has a good relationship with the founder and is a top technical expert in the business. he is reaching a retirement horizon and has confirmed that the future lies with her. He has said that the business will one day be hers and that incentives will be provided to ensure her slice of the pie should she bring new business in.
She wanted a framework and a plan on how to engage with the founder in this light.
This type of proposal is a management buy-out. The current management (that’s her) is promised the business as part of the founders exit and succession plan. These types of exits come about for several reasons.
- The business is not saleable and closing it down comes at a great cost
- The founder has no family interested in taking the baton and running with the business
- The founder needs a retirement solution since there won't be a capital gain off a sale, nor has he provided sufficiently for a future without a salary
Who are the parties?
There is the founder and the successor.
The successor in the case above needs to get certainty of the deal. Is it real or not and how will it happen? She could rely on the goodwill and honour of the founder at the risk of giving up her prime economic life waiting for something that never happens. At the same time, is it a great offer or deal? She needs to find this out now. Finally, how will it work. The best way to remove uncertainty is to put a plan of action in place.
The founder is going to feel fraught and ambivalent. He needs to hold her talent, energy and drive but most likely has no idea how to structure the deal. His timing of it will flux too depending on his mindset. Is it a 3 year or 7-year deal?
Any business owner has attached a large part of their life and meaning to the business they have built. In their minds it always holds the full potential of what it could’ve been but isn’t right now. Should they exit, what will they do with their lives and time? Finally, how will they get the deal done to secure an ongoing salary but without the responsibility? If they agree terms and the successor fails, they lose their future salary stream that they need!
Prepare and plan for the negotiation
- Establish the intent for exit and acquisition for both founder and successor
- Establish the viability of the current business
- Establish the exit criteria including the money required
- List your fears and apprehensions for both parties
Preparation in any negotiation is paramount. Having a clear sense of what you want and why helps you understand what to fight for and concede. Learning what your counterpart wants and needs also builds empathy on both sides. This often opens the door to a genuine engagement that sees both parties walk away with what matters most to them.
A management buy-out of this nature can only work in an environment of honesty and openness. It’s a small business and has a small, closely-knit team.
Put a plan in place
The starting point is the process or plan of action. It should include the following steps:
- Signature of confidentiality agreements to build trust and formality
- Confirmation of intent and reasoning behind the deal to build empathy and options
- Sight and discussion of financial information to assess viability and potential
- Establishment of the principle terms of exit and acquisition to establish process and certainty
- Establishment of a timeline driven by activities and milestones to establish goals and progress
The starting point is to agree a governance structure to protect each party and the business. This means that a confidentiality agreement should be put in place to prevent the disclosure of the intended transaction and exposure of financial information to outside parties. Often, in small businesses, books are structured to suit the requirements of the founder and this is confidential information.
Empathy and understanding
The preparation work above needs to be discussed. Again, under the protection of the confidentiality agreement, both founder and successor need to be clear about why they are doing this; what their expectations would be; as well as concerns.
Looking at and reading the numbers to understand the viability of the business is critical. The founder can demonstrate the true value of the business and talk to the opportunities not yet secured. The successor can evaluate their potential and interest in the value of the opportunity. This increases their commitment.
At this point, both parties can start to negotiate the principle terms of exit. Is it for value, if so, how much and over what period?
The action plan should involve re-establishing the vision of the business as well as a plan to achieve it. Ideally, this includes:
Re-evaluate the positioning of the business and establish a strategy that plays well into the future. Visit customers and suppliers together and re-inspire the businesses vision.
Build systems to secure the businesses future. The heavy-lifting here should be done by the successor with the guidance and sign-off of the founder. It should also happen across all functions of the business over a 24-month period. The outcome will be a successor that has full control over the business and a founder that can ease back and retire with peace of mind. It also establishes the successor as the new leader in the business and manages the hand-over of relationships.
The action plan should contain clear milestones of achievement. In each milestone, value should be exchanged between the parties. Over the 24-month period, the founder needs to be paid out and the successor needs to be in control. This period can extend beyond 24 months into 36 months. Longer periods than that become troublesome to maintain.
Draw Up Agreements
With all the planning above in place, reduce the principle terms, timelines and process to an agreement. This way both parties are protected.
Working with Aurik we have a structured approach to help any established business owner manage the succession of their business. We work with you to create a sustainable deal and most importantly, a process that ensures the sustainability and growth of the business.