Pros & Cons
[fname], your core management team was likely instrumental to building your
successful business enterprise - and it may seem natural that they should be
the ones most likely to succeed you on your business exit. Without
preparation and foresight, however, the transfer of power, and company
value, to a member or members of your management team can be a difficult and
jarring experience for all involved.
When considering a business transfer to key employees or a management group,
an exiting owner must explore his or her personal needs to ensure that it is
a solution appropriate for his situation. An owner must be aware that
management buyouts will likely result in significantly less cash at closing
to the owner, who often holds the majority of the stock, and risk, of
the business while the buyers make structured payments on the principal plus
interest over time.
Without a financial backer behind the transaction, the business' existing
assets may need to be used as collateral for a loan toward the initial
down-payment to the exiting owner, who will also accept deferred payments
when the business produces future profits. An owner must therefore have a
high financial, and relatively low mental readiness (i.e. long time
horizon) to leave the business to strongly consider a gradual management
buyout. The majority of one's business wealth remains locked in this
scenario, still at risk while under new management
Due to this, the owner will often remain in a managerial role in these
situations, making a management buyout a potentially attractive proposition
for owners with a moderate or low mental readiness to exit.
Many business owners, however, underestimate their personal ties to the
business. On seeing changes, minute or drastic, to what had been their
business, it is natural to feel slighted and to potentially regret
transferring the business. If the owner has remained in a key role and/ or
maintains a majority share of the business, conflicts could erupt,
eventually leading to a failed exit and a weakened business.
It's a Matter of Perspective
Prior to that point, it is important for an owner to consider the
possibility of difficult negotiations with key employees, which may also
impact business relations and the owner's personal net worth. The owner's
value of the business may differ significantly from that of the prospective
management team, and it is also important to acknowledge that not every
employee is meant to, or desires to, be an entrepreneur.
Generally, the positives of an internal transfer can outweigh the
negatives for an exiting owner comfortable with the management team taking
over. Structuring an internal transaction as such can allow the exiting
owner more control over the transaction and the time-frame of the takeover,
as well as ensuring that company shares go to the intended beneficiaries in
as tax-efficient a manner as possible. This internal structuring is not
ideal for each exiting owner, however, as the valuation of the business is
typically lower than it would be in an external transfer, and the owner's
decreased payout will still be dependant upon the future success of the
business, which he or she no longer controls.
Management buyouts are technically deemed internal transactions, but
are not subject to the fair market value standard as are gifting transfers
of ownership. In a cross with external transfers in this way, management
buyouts require the managers to act as the "market" in determining a value
for the business representative of their expected returns on the investment.
An owner must consider his or her financial and emotional readiness prior to
contemplating all exit options, including management buyouts.
Management buyouts offer strong pros and cons for
the exiting owner and his heirs, depending greatly upon the
owner's ability to achieve financial goals without solid income from the
proceeds of the business sale. This is a very conservative, but realistic
approach. The owner often will be asked to stay on for a pre-determined
period of time to assist in the business transfer, and additional bonuses or
incentives may be provided in return for investments returns.
An MBO permits the owner a level of flexibility
not available in most alternative exit options, allowing him or her to set
responsibilities and guidelines gradually over time to ensure the transfer
is a good fit for all, and for the owner to mentally prepare for the
At the end of the day, an MBO may be an exiting owner's best or only option.
Therefore, proper planning and a timed and strategic exit is recommended -
Leave the proper amount of time to carefully address the effectiveness of
this option for your business exit.
As always if you need some advice, you're
welcome to email me of call me here at the office at 281-993-4530.
Charles Wilson, CPA/CFF, CGMA, CBEC
Charles Wilson, LLC
307 S. Friendswood Dr, Ste B-2
Friendswood, TX 77546
Charles Wilson, CPA/CFF,
CGMA, CBEC is a Certified Business Exit Consultant and is affiliated with
Pinnacle Equity Solutions, Inc., an Exit Strategies Training and Solutions
company. Parts of the content in this email are taken from previous
Pinnacle Equity Solutions, Inc's. newsletter library and website in
accordance with Charles Wilson's certification in Pinnacle's Certification
and Membership Program. All Copyrights are the properties of Pinnacle Equity
Solutions, Inc. and Charles Wilson, LLC and their respective owners.