Internal Management Buyout: Another Exit Planning Option: Sell to Management
The one exit planning strategy that most often gets overlooked is an internal management buyout but it’s an approach that has several advantages that owners should seriously consider. This post is a very short explanation of 1) how an internal management buyout works, 2) who an internal management buyout works best for, 3) benefits and 4) initial planning steps for those considering it.
How an Internal Management Buyout works
In an internal management buyout the company borrows capital typically from bank or non-bank lenders that is then paid to the exiting owner who sells his ownership back to the Company. This transaction can be done for all or part of owners’ equity interest. Once those shares are retired, new owners then purchase new shares by either investing capital, getting new shares granted (for free) or borrow money (often from the Company) to buy the shares then pay back the loan out of future owner profit distributions. Internal buyouts can be done all at one time or over multiple transactions.
Who an internal management buyout works best for
An internal buyout works best for companies that have solid cash flows and solid management. Solid cash flows means the Company makes enough free cash flow to support debt capital that is secured by the Company and paid to the owner. Solid management means the Company’s management team is already successfully running the business and can be responsible for the future of the Company.
The selling owner gets his money upfront. If the debt is negotiated without personal guarantees, there is no personal financial risk for the selling owner or the management team (new owners) because they are not personally liable for the debt. Selling owners are also often able to construct a buyout at a higher valuation than a sale to a 3rd party. To arrive at a valuation, companies can either do a self determination of value, hire an appraiser or proactively shop the company to interested 3rd party buyers then let bids from third parties drive the price (i.e. management must match the highest offer). Internal buyouts also allow selling owners the opportunity to stay in involved after the sale of the business.
Internal Management Buyout Initial Planning Steps
Many owners and managers never consider this exit option because the conventional wisdom is managers can’t afford to buy a Company; however, in reality it’s the cash flows of the Company to support the buyout that matters the most and that’s typically true for all types of buyout and sale transactions.
A key initial planning step is to figure out if such a transaction is feasible for your Company. Key considerations include assessing:
(2) management’s motivation and capabilities
(3) likely financing options given Company’s ability to support needed financing.
Some companies may be able to self assess many of these considerations but if you need help or have questions, just call us we’d be happy to help you assess this potential win-win exit strategy.