Rob Starr, Head of M&A at Shaw & Co, shares his wisdom on how to onboard a management team to business ownership during an exit via a Management Buyout (MBO).
An exit via a management buy-out can create certain frictions as the deal progresses thanks to the differing objectives of the parties involved. But how do you ensure that the management team is able to smoothly take the reins while you are also finalising the deal?
"Always keep the sale confidential until the deal has been completed."
It is important that confidentiality is maintained during the process, not just to protect key proprietary information. A leak - or even rumours - can affect a company’s operations, ranging from employee attrition and general disruption through to potential supplier issues and loss of customers as competitors seek to exploit the situation. The result is that the value of your company can plummet, and it could lead to the collapse of the deal.
It is therefore incredibly important to keep the sale confidential until the deal has been completed, and with those informed being under no allusions as to the importance of confidentiality. For certain key individuals who may not benefit from the deal, putting in place a financial incentive and/or offering assurances (where this is possible) may be required, but a key aspect is maintaining trust which requires integrity by those involved.
"It is vital that your management team is sufficiently competent and dedicated."
If the intention is to hand the business on, then both debt and equity partners will be looking for a strong management team. Succession planning is therefore an important requirement and it is your role is to develop the management below you or to hire in to post. If it is the latter, then ideally, they need to be employed for at least 12 months, preferably longer, unless they are seasoned managers in a particular sector.
As the exiting shareholder it is vital that your management team is sufficiently competent and dedicated. You are likely to need 24 months to affect a transition and at a certain point during the transaction they will need their own advisors. If existing management do not receive any cash from the sale, then from an equity perspective due consideration has to be given in how the cash is raised for the management team’s personal investment.
Even for a trade sale, management can be a key attractive aspect to the business and understanding and addressing concerns of management at the front end of a process allows for these to be factored into the negotiations and prevents misunderstandings at a later stage that can derail or delay the process. As they are likely to be non-shareholders, employment terms and incentive plans to encourage managers to remain will need to be agreed alongside the share purchase agreement.
Management's negotiation with a financial sponsor (private equity) is strongest in the early stage of a transaction and even in a ‘friendly’ buy-out they will be on the other side of the table at some point.
Management will want to ensure there is sufficient funds raised for future working capital, business expansion and other contingencies and should want to maximise their share ownership (equity allocation) and service contracts (remuneration).
Time should be allocated in the transaction process to allow for discussions on the service contracts with the management team whether it be a trade acquirer or private equity backed MBO. This will assist in the understanding between parties and in building trust, with any concerns or matters being resolved and dealt with as part of the overall negotiations.
"All parties must be comfortable and supportive of the transaction."
For private equity backed MBOs, during the process management may have a strong preference for a particular financial sponsor, which can create a level of risk if they are not a preferred bidder and not successful. The advisor needs to manage relationships so that the balance does not tip towards only one financial sponsor by keeping alternative options and management relationships open. If one financial sponsor becomes so embedded with management, it can provide a level of leverage on the sale terms and pricing.
The aim is to achieve a balance where all parties are comfortable and supportive of the transaction, whether it be a trade buyer or private equity backed MBO.
One way you can align your management team with the performance of the business ahead of the sale is to allow your key team members to benefit from the transaction, which can be achieved through a management incentive scheme. Putting in place an appropriate scheme allows you to motivate your managers to grow the company and to hit targets that will increase its value ahead of a forthcoming sale.
Managers will receive shares in the business normally at the sale event and are rewarded for their efforts and staying with the business until an eventual sale. If the management team is to be part of a buy-out, the funds received from the shares (normally in a tax efficient manner), can be used for all or part of the cash investment required in the new company capital structure.
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