There are many techniques and structures that a privately held business owner may consider in planning for the succession of the business. One such succession option is the management buyout. Simply put, a management buyout consists of the management team acquiring all or part of the business. In many cases this includes the use of company assets as collateral to secure financing, whether it be from a third party lender or by way of a vendor take-back, or a combination of the two.
There are pros and cons to most succession plan options. Potential limitations to consider for a management buyout are: management buyouts tend to be earn-out based; use more of the company profits to pay for the business; payments are made in post-tax dollars; a longer time to pay is usually required; and the retiring owner will have to maintain some level of involvement for a period of time.
Alternatively, the management buyout may be beneficial in that it allows the owner to maintain more control and ensure the business is in a better position should it need to be taken back over. If the owner is financing the sale then the owner can get the best price and most advantageous deal structure. Since the new owners know the business, there is reduced risk to the business, employees are less likely to be apprehensive and existing clients and business partners are usually reassured by the continuity. The due diligence process and transfer of responsibilities will be less onerous, timely and will remain confidential.
Once a management buyout has been approved as the succession plan of choice then a valuation of the business should be completed, a purchase price agreed to and financing terms established.
As mentioned, although vendor take-back financing is common in these circumstances, other types of financing are usually combined with it to achieve agreeable payment terms. These include use of personal funds and equity of the purchasers, loans or credit notes from banks, installment purchases of the shares of the business and sometimes the selling of stock options. In the end the deal must be financeable on reasonable terms to ensure remaining payments are made and the business can carry the cash flow burden of the buyout. The management buyer should put as much money into the deal as they reasonably can and the unpaid portion must be secured.
Security usually takes the form of a pledge of the purchased shares (if a share deal) plus security over all assets of the business (subject to any priority required by bank financing).
Succession planning is about taking control of the inevitable. Eventually, every business owner will leave the business. A management buyout can be a very satisfying and practical way for an owner to exit their business. The keys to good management led buyouts include excellent professional advisors and lots of patience when putting the deal together. If an owner plans for an orderly transfer, he or she can reduce the taxes paid, get the maximum value out of the business, leave it in the hands of chosen successors and avoid family business crisis.
This article is prepared for general information purposes only. It is not intended to be used as legal advice or opinion. Specific legal advice on the particular matters described in this article should be obtained from competent legal advisors. We would be pleased to provide additional details on request and to discuss the possible effect of these matters in greater detail.