Is a Management Buyout the Right Choice for Your Company?

Explore the benefits and challenges of management buyouts as a business exit strategy. Our comprehensive guide helps business owners understand if this transition is right for them, considering their financial goals and risk tolerance.

Key Takeaways:

• Understand your business transition goals and what is required to achieve them.
• Management buyouts can offer flexibility and personal fulfillment.
• Selling to a management team can be riskier than other options.
• Planning for management buyouts early can provide insight and mitigate risk.

For many business owners, transitioning their ownership is one of the biggest and most important decisions of their lives. Their businesses are often their single largest asset and a reliable, long-term generator of family wealth. Perhaps more importantly, these ventures have been part of their identity for many years. Choosing the right exit strategy can make the transition a little easier. Management buyouts are one option to consider in that regard. Selling your business to its management team, or to key employees, puts the results of an owner’s hard work and success in the hands of knowledgeable trusted staff.

Making Informed Decisions About Management Buyouts

When assessing any type of transition, it is important to understand your goals and needs.

Each of the following considerations can provide insight into the transition that’s right for you:

1. How much money will you need to achieve your goals?
2. Do you already have enough money, or will you need proceeds from your business to accomplish your personal objectives?
3. How much risk are you willing to take in transition?

These three questions, when considered together, may be the most important questions in the entire decision-making process. The answers will likely influence all other actions you take.

If the answers to the above leave open the possibility of a management buyout involving company leaders or key employees, and if this type of transition is appealing to you, then the next step is to fully understand the implications of an internal transfer. 

Establishing Successful Internal Transfers in Management Buyouts

Transferring ownership to a management team or key employees is inherently different from other types of transition alternatives, as it involves both greater familiarity and potentially increased risk. Management teams and key employees to whom you would consider selling (or gifting) ownership are often long-term contributors with whom you have much experience and strong emotional connections. This combination can make the process easier in some ways and more difficult in others.

Often, an owner’s affinity for their long-term employees is similar to the feelings they have for their own children. Because of this dynamic, transitioning owners may feel compelled to make economic decisions that are highly influenced by emotional factors. That is, you may wish to transfer your ownership for less than full value or under terms that are not primarily driven by economic factors. There is nothing fundamentally wrong with these actions, if you understand the impact to yourself and the way they fit into the answers to the three questions above.

For example, selling to a management team may require you to finance the transaction by holding a note for the buyers. That is unlike a sale to an outside third party, in which you would likely receive a substantial portion of the value of your business up front and in cash.

The probability is high that your internal employee buyers will not have the resources to pay cash for your business. That means that you will carry a greater level of risk than you would otherwise, including operational risk, interest rate risk, and repayment risk. Because you will be a debt holder to the owners, who will be dependent upon the company to provide the means of repayment, the ongoing success of the business may determine whether you can meet your financial needs (depending on the answers to the first two questions).

Remember that, in many scenarios, you will no longer be in control of the company but will still be dependent on its ongoing success. Of course, if the answer to the second question is that you have enough money already and don’t need proceeds from your business, the risks are lower, and the issue may be moot. 

Transferring ownership to a management team or key employees is inherently different from other types of transition alternatives, as it involves both greater familiarity and potentially increased risk. 

Attention to Detail: Crucial for Success in Management Buyouts 

The risks and limitations associated with this type of transfer make it essential that you carefully consider the form and structure of the transaction. One of the great aspects of a management buyout is that you will likely have the leverage to dictate certain terms. Because the buyers would otherwise have no ability to own the business, you will be in an enviable negotiating position.

How much you will transfer, to whom, when, and under what terms, are all considerations fully in your hands, generally speaking. Therefore, it is extremely important for you to consider the ramifications of each of these decisions, and to plan for various contingencies.

Protecting yourself from the risks discussed above is as important as any part of this process and can be accomplished in many ways, including a written buy-sell agreement, certain protective clauses in the debt instrument, and simple financial analysis of the business to understand its ability to generate cash flow to pay the purchase note.

Some questions to ask include:

• How much involvement in management do I want going forward? For how long? 
• How do I decide who gets ownership? 
• Can the new owners work together effectively? 
• What should be the price and terms? 
• What’s my “Plan B”?

For help navigating these questions and more, contact your Comerica Relationship Manager or request to speak with a Business Transition Professional today.