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Management buy-outs: A five-point checklist for success

A management buy-out can be a highly attractive business proposition for private equity backers and for the management team itself. Here, David Baxa of VISTA Technology Services, provides a five point guide to a successful MBO.

Private equity firms and banks are almost always interested in backing high quality management buyout transactions. The valuation of a company is usually appealing in a buyout, and the management team is demonstrating success-oriented initiative in pursuing the buyout.

At VISTA, our experience has led us to develop a checklist of questions that management teams should consider in pursuing a MBO. If you have positive answers for these questions, you can be confident that your buyout strategy is prepared for success.

Question 1: Are the internal environmental conditions right? The ideal environment is one where the parent company has stated its intent to sell off business units and is prepared to entertain buy out offers. This provides a conducive environment for the management team to step in and make a credible offer that can be taken seriously. When the timing and circumstances are correct, both parties can focus on the primary goal: arriving at a fair price.

Internal environment conditions for a successful management buyout don’t happen that often. When a management buyout offer is presented in a hostile fashion or in a contentious situation, there is high potential for a lose-lose scenario, which makes it difficult to firm up financing commitments.

Question 2: Is the business “finance-able”? History of performance, positive cash flows and profits are all key factors in financing your buyout. You will also need tangible and intangible assets, as well as a management team that can make the best use of those assets after the transaction has been concluded.

Before you begin, make sure you have either hard assets that will support a financing base or intangible benefits against which an outside party will be willing to create an equity financing arrangement. Strength of management team, intellectual property, and customer relationships are all important.

In VISTA’s case, the management team has been together for 15 years, and the leadership was responsible for a successful track record of business development. That, along with a history of revenue growth and steady profits, proved attractive to management’s financial backers.

Question 3: Are there legitimate business benefits for the management team in buying the company? Deciding to be your own boss is not the right motivation to embark on a management buyout. You need to have confidence that you can create a unique value proposition that would not necessarily apply in any other ownership scenario.

As stated at the outset of this article, VISTA management realized that acquiring the company would allow them to establish a unique and focused brand in the Federal marketplace and create an entity with the status of a wholly Veteran-owned small business.

This has already created new business opportunities for VISTA and has made VISTA a valuable partner to larger contractors who would otherwise be precluded from consideration for certain government contracts. Likewise, VISTA’s long-standing client base now gains the benefit of being able to fulfill its federally-mandated small business contracting requirements by working with the newly bought out company.

Question 4: Are external capital market conditions right? In almost all circumstances, the moment management announces its desire and intent to complete an MBO, a natural strain occurs between the business and its parent company. These two parties no longer share the same objectives, even in friendly circumstances. Suddenly, the parent company’s perceived ability to maximize its value in a business unit is impaired. Make sure you test the appetite of the capital markets for your transaction. You need to know you can get your deal financed and you can proceed quickly towards a transaction before you approach the parent company. This must be done discreetly to avoid creating unnecessary strain in the event you determine your proposed transaction is not supportable with external financing.

Before even discussing the possibility of a MBO with the parent company, we at VISTA spoke with several commercial banks and private equity firms to understand what level of financing was possible, and at what valuation. This process also provided us with valuable insight into how these organizations valued our business, which greatly facilitated our negotiation with the parent company.

Keep in mind that a MBO could have the effect of limiting the current ownership’s selling options. As soon as management expresses their intent to purchase, and they can demonstrate that they have the financial backing to afford it, the ability of the current owner to sell to outside interests is diminished since few potential buyers may want to buy the company if the arrangement is not supported by management. For this reason, it is important in negotiations to demonstrate that the management team is offering a fair price for the business based on what the capital markets will support.

Question 5: Are you ready to act quickly? As mentioned, being prepared to consummate the transaction before you go in to negotiate the deal is critical. In addition to having your financing tentatively arranged, make sure you know what your primary deal negotiation points will be. Be prepared to be flexible on representations, warranties, and indemnification. After all you should know the underlying risks in your business.

Make sure you keep all assets in mind. Consider whether your business has established a brand reputation that’s solid enough to continue operating under the same name. If so, make sure the current owners transfer to you the rights to certain marketing-related intellectual property, such as corporate logo designs. You may want to consider providing your parent company with some future upside in the form of warrants or a future balloon if things go according to plan. It helps keep them vested in your business, which could prove to be valuable down the road.

It may be advisable to have a third party negotiate the transaction with the owner on the management team’s behalf. The primary advantage is that it allows management and ownership to maintain an amicable and positive relationship through the process. It puts the hard work on the shoulders of a third party. (In VISTA’s case, this was not necessary, as the management team successfully negotiated directly with the owners.)

There is real appeal to being master of your own destiny. Management buyouts enable the management team to take control of the business and enable it to achieve its maximum potential.

If you can answer yes to the questions posed above, seize the opportunity. The key to your corporate growth is entirely in your hands.

David Baxa is President and CEO of VISTA Technology Services, Inc., a leader in facilities infrastructure analysis, IT and management consulting to support Defense Transformation and civilian agency efficiency requirements. He is a member of the National Capital Chapter of the ACG. David can be reached by email at david.baxa@vistatsi.com, or by phone at 703-561-4100.