Caution! A Management Buyout May Not Be the Way to Sell Your Company by Roger Neu
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ou own your business and have been agonizing over having to go through a marketing and sale process and then not knowing what will happen to your employees. Then, what you believe to be the perfect solution appears right inside of your organization. A key manager or group of managers has approached you with the proposition of buying the business. The discussion then centers on how you can avoid having to take the company to market and how management’s purchase will provide certainty for the ongoing employment of your employees. Well, nothing could be further from the truth. One of the first things management will say is that they can come up with at least 25% of the purchase price. Let’s use a $50M sale price which means they would provide $12.5M. TRANSLATION: “Management believes that a bank will lend them $12.5M against the assets of the company.” So what management is really doing is the same thing that any buyer would do, which is using your assets to obtain senior debt from a bank for a portion of the purchase price. They are not putting their own money into the deal as equity. Since the managers have little or no funds, they will now take it upon themselves to go to the market to find private equity funds and mezzanine lenders to fund the balance of the transaction. TRANSLATION: “You are not avoiding taking the company to market, but have, in fact, put the marketing process into the hands of management instead of controlling the process yourself.” Numerous articles have been written over the years that address the inherent conflict that exists when the person that is marketing the company (management) is the same person that is buying the company (management). Two key problems arise. First, management has no incentive to get investor groups to put a high value on the company because it will reduce the percentage that management can retain. A $50M value may require an equity investment of $20M.
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Attorney Journals San Diego | Volume 224, 2022
If management has $4M to invest and outside investors add equity of $16M, management only gets a 20% interest. If, however, the total price is $40M with only a $10M equity requirement, the investor equity would only need to be $6M and management would retain 40% of the Company. Second, a quasi-fund raising and marketing campaign by the managers will pollute the buyer pool in numerous ways that will be detrimental to a future sale if management is not successful. The managers will assure you that they will be the ones doing the heavy lifting to get the deal done and it won’t be at all onerous for you. TRANSLATION: “Instead of putting their full attention on running the company, management will now be busy trying to organize their own buyer group and trying to put funding in place. In addition, you and the company will have to do all the same work (and usually more) in providing due diligence information to various private equity groups and lenders.” No investor is going to provide $50,000,000 in funding without putting you through all the paces. Management will also be in for some surprises. Management told you how they are going to purchase the company and protect the employees. TRANSLATION: “He who has the money rules and if management is not putting up a significant portion of the equity, management will not control the company.” The investors will control the company and will operate it to obtain the highest rate of return without regard to retaining all of the employees. You, however, could be in for the biggest surprise of all! Even if you do sell to management, what is to prevent them from reselling the company in six months, one year or whenever? So, even if management, by some unusual set of circumstances, actually did acquire control, they could resell in a short period of time to a totally unrelated party and the guarantee for your employees and your continuing legacy that you thought you had will no longer exist.
