Handing over the keys so that everybody wins

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This article appeared in the April 2010 issue of CRN magazine.

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Handing over the keys so that everybody wins
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You have built a strong reseller business from scratch but now you feel you don't have the same energy anymore. It's time to move on and seek new pastures, perhaps retire. You can do a trade sale and have everyone coming in to kick the tyres. Or you can sell the business to your managers who have been with you for years and who know it inside out.

Alternatively, you are the company's managing director and reckon you have been doing a pretty good job running it for the past few years. But you have a sneaking suspicion you might not figure that highly in the owner's long-term plans and, in any case, you have always wanted to run your own business.

In both cases the best solution might be a management buyout (MBO). Done well, it can produce winners on all sides. For the owner of the business, the MBO can be a good succession planning tool. It's all about handing down ownership of the enterprise to a keen management team that already knows the ropes.

It is also preferable to a trade sale which although it can maximise the sales price can create all sorts of tensions. When your business is on the market, confidential information about strategy, profit and loss projections and cash flow forecasts must be released to interested parties, many of whom could include competitors who may or may not buy.

Furthermore, owners are more likely to discount the price a little rather than selling to a competitor. They might feel that people who have put many years into the business might deserve first bite of the cherry. If they can keep things in-house, and sell the business to people they trust, the price could be lower.

The first and most obvious thing to do is to establish whether there is a willing buyer or seller. This can be a delicate situation and needs to handled with care. There have been occasions where management has said it would like to buy out its division and the owners have said no.

Subsequently, management ended up leaving.

Similarly, there have been occasions where owners approached managers about a sale but the management said they weren't ready. However, the signal had gone out that the business was up for sale and management ended up leaving.

The second step is to establish whether a management buyout is viable. Most MBOs are backed by private equity firms and these are gaining frequency in Australia. Private equity firms however have very strict criteria for the investments they make. They also require a detailed business plan.

Furthermore, successful MBOs require a different mindset to traditional management because the investors and managers become the owners. For the managers, this can be a massive shift, and many might not be up to it. The MBO is the first time they will be flying solo without support of head office.

Second, managers of bought-out businesses have to be aware that private equity is not there forever. They need to ensure they have the business exit-ready within three to four years. What's more, they would need to do that with the pressures flowing from a highly leveraged balance sheet.

Third, they need to understand that cash really is king.

The quality of management however, remains critical because you are asking investors to back you as a team and a private equity firm to buy into the ability of management to add value.

This means all key positions need to be occupied by competent people. And it will be critical to look at the second tier of management so that investors know there is a succession plan.

The MBO will require an enormous amount of debt and the business will need to produce plenty of cash to service that debt.

What backers are looking for in a management team is commitment. As a result, they would expect the management to put up some of their own money and have some "skin in the game".

If the manager is prepared to take out a second mortgage, that might create a strong impression.

But private equity firms would not want the managers to have everything invested in the company as that would put too much pressure on them. What the investors are looking for is experience and expertise rather than cash.

Finally, it is important to remember that MBOs are time consuming. A typical MBO can take anywhere from three to six months to complete. Another problem is that management needs to have systems in place to ensure they don't get distracted in the process.

Most people only go through one MBO in their lifetime. That is why it is a good idea to talk to others who have completed a similar transaction to find out what might be needed. Appointing independent advisers is also important. The advisers will conduct feasibility studies, help prepare the business plans and negotiate the funding.

For all the parties concerned, the MBO is a life changing experience. Handled well, everyone will be a winner.

Next page: Many resellers leave it too late to consider a management buyout

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