Rahul Ganti

Critical question Do any case studies/articles suggest that companies benefit from allowing their junior managers to buyout divisions? Specific to your case, this may be considered as management buyout though officially you are a third party buyer/acquirer, but since you are a former employee of xyz company and still have great relationship with the top level executives and mid level management, I consider this as MBO. My research says that there are great advantages in allowing the managers/team to buyout division of a company. It’s a win-win-win situation for all three entities, the Company, the Seller (owner) and the buyer/acquirer. The available options to the seller when considering the sale of their company/division: • • • • Selling the business to a competitor or private equity firm Selling a portion or all of the business to an employee stock ownership plan(ESOP) Transitioning ownership to the next generation of the family. A potentially attractive alternative includes selling to the company's current management team. The question is what makes a management buyout (MBO) attractive to the seller as compared to a third-party sale? • • • The first advantage is speed o MBO typically can be faster than an auction process. Second is confidentiality o Seller may favor a management buyout transaction for confidentiality purposes. o MBO allows a shareholder group to avoid selling to a competitor and putting potential trade secrets or sensitive customer information at risk during the due diligence process. Third is familiarity o The management team has been running the business and is well known to the selling shareholders. o Reward the management team for loyal service in running the company or to recognize strong performance in growing the business. Management Benefits • • Transition o Smooth transition during this change, the current management team will fully understand the company, its operation, supply chain, routes to market and potential growth Motivation and sense of ownership o Motivational levels increase as a result of MBOs due to a sense of loyalty and belonging. o Ability to influence how the business is run, how it can grow and can make the important decisions that are often left to parent companies. o Factors such the protection of IP, sales strategies and product development will be considered as top priorities. Seller Benefits • • For the business owner it is often a chance to retire and unlock their wealth in the business. For corporate parents, these transactions provide an opportunity to divest non-core operations and raise cash. Management Buyout Overview A management buyout is a transaction in which the current managers of the company (not necessarily members of the management board as such) take control over the company by buying out a controlling stake in the company’s shares—either independently, out of their own funds, or in cooperation with investment funds, such as a private equity fund. Because an MBO involves the current managers, it should be distinguished from a “management buy-in” (MBI), in which the buyout is conducted from “outside”, by persons other than the current management who plan to assume management of the company in the future, or a “buy-in management buyout” (BIMBO), which combines the features of an MBO and an MBI. Purpose • • • • • MBOs are favored exit strategies for large corporations who wish to pursue the sale of divisions that are not part of their core business, or by private businesses where the owners wish to retire. The financing required for an MBO is often quite substantial, and is usually a combination of debt and equity that is derived from the buyers, financiers and sometimes the seller. Management buy outs are conducted by management teams as they want to get the financial reward for the future development of the company more directly than they would do as employees only. A management buyout can also be attractive for the seller as he can be assured that the future standalone company will have a dedicated management team thus providing a substantial downside risk against failure and hence negative press. In the case the management buyout is supported by a private equity fund the private equity will, given that there is a dedicated management team in place, likely pay an attractive price for the asset. Concerns • • • • • • • Asymmetric information possessed by management may offer them unfair advantage relative to current owners. The impending possibility of an MBO may lead to principal–agent problems, moral hazard, and perhaps even the subtle downward manipulation of the stock price prior to sale via adverse information disclosure, including accelerated and aggressive loss recognition, public launching of questionable projects, and adverse earning surprises. Corporate governance concerns also exist whenever senior management is able to benefit personally from the sale of their company or its assets. (eg. large parting bonuses for CEOs after a takeover or management buyout) Transition from being employees to owners, which requires a change in mindset from managerial to entrepreneurial. Not all managers may be successful in making this transition. Seller may not realize the best price for the asset If the existing management team is a serious bidder for the assets being divested, the managers have a potential conflict of interest. Downplay or deliberately sabotage the future prospects of the assets that are for sale to buy them at a relatively low price. Financing methods • • • Debt Financing Private Equity Financing Seller Financing The graph below depicts an MBO deal where the business is worth $5m at the transaction date. Management are required to invest only $200k, the remainder of the deal is funded by debt of $3.8m and deferred consideration of $1m. As the value of the business increases under new ownership and the level of debt is repaid, the value owned by the management increases substantially. After 5 years the business in the illustration is worth $14m, all the debt is repaid and 100% of the business is owned by the management. Therefore, after a $200k stake and 5 years work, the management have made 69 times return on their initial investment. Even if the business didn’t grow managements’ value would still yield a 25 times return for the MBO team. 1 Feasible conditions for MBO • • • • • • • • The owner must be willing to sell. This is often the key stumbling block where the owner has not emotionally accepted retiring. The owner wants to sell to the manager. Establishing a strong relationship with the owner is critical to managers pulling off an MBO. The business must be viable and capable of supporting outside financing. The team of buyers must have broad capabilities to run the business successfully, a strong reputation with stakeholders and the ability to take on the responsibilities of ownership. Business must be a division of a larger company The division must be able to be viable as a standalone entity and able to support a separate financing structure. Cash flows of the business must be sufficiently strong to support debt service and allow for value creation opportunities. Banks and investors will need to see the ability to grow the business through attracting new customers, entering new geographic regions and potentially adding new products or services. Employee Benefits • 1 Smooth transition is important for employees because it reduces feelings of uncertainty and anxiety over whether job losses will take place. Source: Robert Napoli is vice-president of First West Capital and President of the Association for Corporate Growth Vancouver Chapter. He has financed dozens of acquisitions, management buy outs and growing companies as the head of the $100 million subordinated debt fund First West Capital, which is part of First West Credit Union. • • • • • In many MBOs, a new management team is appointed. They may have a different viewpoint on many of the current company operations, including staffing requirements. Unfortunately, this can lead to redundancies or reduced hours. Employees throughout the company, from middle management to shop-floor staff, will benefit. As the company grows and becomes more profitable, there are likely to be wage increases and employee benefits such as pension schemes, private healthcare and bonuses. Improved performance and productivity is not restricted to management. Employees will be more inclined to work for the people they know already and will feel more comfortable raising concerns. Financial Partner Benefits • • Management buyouts are also a sensible option for the banks, venture capitalists or investors that provide the financial backing to the company. These types of institutions can rest assured that the business will continue to be run by experienced managers and a good workforce. Post-buyout performance • • • • • Global perception that the contribution of the venture capitalist has been crucial to the feasibility and success of the buyout. Without the venture-backed buyout, the organisation would either have failed to survive or would have had limited growth prospects. The buyout companies implement a range of growth strategies in the post-buyout period, and that these strategies generally lead to significant increases in turnover and pre-tax earnings. The post-buyout improvements in competitive position and financial performance had been significantly greater than those achieved by their competitors. The improvement in competitive position is gained through increased market share brought about by a relatively higher growth of turnover than competitors. Examples and articles 1. Splash Media Group, LLC Completes Management Buyout, Adds Ad Industry Icon to Board of Directors* o Gary Von Kennel, the first CEO of RAPP Collins Worldwide, joins the board of directors that will lead this social media agency and video production facility. 2. Transcend Corporate has advised Newco, SG Magnets Holdings, and its Management Team on the Management Buy-Out of the SG Magnets group of companies (“SG Magnets”)* The Insider's Guide to Buying Your Own Company* American Capital specializes in working with management to structure buyouts of corporations, subsidiaries, divisions and product lines* Management Buyouts of US-listed Chinese Companies* MBO by Howard E Johnson* Management Buyouts Can Be Too Cozy* The effects of management buyout by operating performance and value* 3. 4. 5. 6. 7. 8. Sources http://www.crainscleveland.com/article/20140122/BLOGS05/140129918/-1/blogs05&template=printart http://www.easier.com/102498-the-benefits-of-a-management-buyout.html http://www.biv.com/article/20121113/BIV0327/311139938/-1/BIV/key-factors-in-executing-a-managementbuyout