Management Buyouts

A management buyout (MBO) is common in the middle market. Often, your management team may have aspirations to become business owners. Your team may be a source of potential leads to buyers, or they may cause conflicts and hold-ups if not handled properly.

Your management team is familiar with your business operations, strengths, customers, competition, and unique advantages in the market. Your current managers, or people in their networks, may have distinct insider knowledge that allows them to quickly pull the trigger, which can be one of the most efficient sales experiences any seller can hope for.

Unfortunately, members of your management team may not have the financial resources necessary to acquire your business and invest in its growth. The adjustment necessary to go from being an employee to being an owner can be difficult for even the most aspiring entrepreneur. 

To sell to your management team or an employee, be prepared to finance all or part of the sale or arrange for a bank to finance the transaction. Private equity firms also commonly finance these MBO transactions.

Disclosing to your management team that your business is for sale may cause some disruptions. Employees may fear the upcoming change and leave their positions or even attempt to undermine the sale. 

During negotiations, the dynamic shifts from an employer-employee relationship to a business owner’s relationship with a business owner. If you begin serious discussions with the wrong person, this can cause tension in the work environment throughout the negotiations and transfer of ownership, especially if discretion isn’t maintained and confidentiality isn’t respected. 

If you have a strong management team that may be interested in acquiring your business, I recommend consulting with an investment banker to determine the extent to which financing may be available to fund the transaction.

Employee Stock Ownership Plans

Employee stock ownership plans (ESOP) are programs in which employees can buy shares of a company under specific terms. An ESOP is technically a defined contribution plan as defined by IRS code, and meets the IRS’s definitions of a qualified retirement plan. ESOPs are complex and expensive to establish – the words IRS and simple never belong in the same sentence. They often require the specialized knowledge of accountants, tax advisers, and lawyers for ongoing re-examination and re-certification to keep the plan compliant with all regulations.

ESOPs are one way to integrate employee ownership in a company, often positively affecting the employees’ commitment, dedication, and productivity. In most cases, selling to one or more employees has significant tax advantages.

Although the process varies, the ESOP typically purchases stock at its inception, using a bank loan. Employees can receive shares as compensation, similar to a 401(k), with the potential for the ESOP shares to vest immediately or over time, as with a pension plan. As employees reach retirement age, they will have options to diversify their ESOP holdings away from company stock or cash out. 

An ESOP structure may make sense for your business, but these normally yield the lowest sales price and are often used only as a last resort. An ESOP is generally only a wise course of action for middle-market business owners who either care greatly about their employees and would like to reward their hard work, or for those who own businesses that are excessively difficult to sell on the open market.