Mergers and acquisitions publicity in the propane and butane industry often overlooks the number of internal sales to managers. But internal sales occur in both large and small companies. This article will focus on an internal sale called a management buyout (MBO), a common transfer method in the propane industry.
Common MBO Obstacles
The most significant obstacle in executing an MBO is that managers often do not have the financial ability to pay for the business. This requires the business owner to structure a plan allowing the company to pay for the transition. Therefore, careful consideration should be given to the many tools available to help achieve the best tax yield for the sale while minimizing the financial risk of getting paid for the business.
Another major obstacle for the seller of an MBO is financial risk. The potential danger of an MBO is that the owner might not get paid. The buying senior management team performance is tied to the cash flow that will pay you. This is why succession is a crucial factor in an MBO.
Securing Successful MBO Exits
The good news is that an MBO exit is flexible and, if properly structured, can have significant tax advantages. In many situations, the MBO will reap a better bottom-line result than an outside sale because of the tax savings. Remember, it is not how much you get but how much you keep. Using the ideal balance and coordination of various tools should result in dollar maximization with risk minimization. Below are business and fundamental risk management concepts for your exit via a management buyout.
Visualize Your Financial Future
Owners can only commit to retirement once they can visualize their financial future with an exit plan. The plan calculates the company’s value before and after taxes, so the proceeds can create the income to maintain the owner’s present lifestyle in retirement. Only then is the owner motivated to lead their team through the MBO and succession process.
While the owner is still in control of their business, they should contribute as much as possible to savings and retirement accounts. This will allow more flexibility around the company’s price during the sale. There are several programs, both internal and external to the business, that are tax efficient for the company and owner. These strategies should be outlined in the exit plan.
Depending on the sales agreement, the owner can still receive benefits during the sale and have those benefits phased out over time. This is all determined in the exit plan and understood before approaching management.
An MBO is a win-win for the buyer (management) and the seller (owner). Management could build significant personal wealth, and the owner benefits by cashing in on the investment built in the company. Sellers also are able to leave a legacy with trusted stewards who bring new energy to the company.
The Company Pays for Everything
I remember in the late 1980s when my owner/mentor asked me if I would like to buy the company, and I said, “Dick, I cannot afford to buy the company.” He said, “Kevin, keep the company growing and profitable, and the company will buy my stock and give it to you.” In other words, the company will pay for everything if you generate profits.
The new shareholders must understand that their stock ownership does not necessarily make them the boss. There can only be one boss/authority. Yes, you are a senior manager and work collectively for the company’s success, but you are an employee first and a shareholder second. As a shareholder, you benefit directly from the success of the company.
With an MBO, there is a risk of the owner not being paid by the managers. That is why it is critical to find the right person who has demonstrated the broad capability to run the company and shows the leadership ability to take it to the next level.
The shareholder agreement must address the four “Ds”: death, disability, divorce and departure. Each of these trigger the buy-sell process. The agreement should consider valuation formulas, funding and transfer of ownership. The agreement should leave little ambiguity for the reader. Remember that in most cases, the document will be referred to by the existing owners, the deceased shareholder’s spouse and legal counsel.
The Golden Egg
The company is the goose that lays the golden eggs. The company must remain fiscally healthy during the buyout and endure the economic cycles. My company, Beacon, kept payments flexible during our buyout even though I had annual notes from the buyers. Why? Because the company came first.
The sale is often funded by seller financing, the redemption of the owner’s share over time or outside funding via a leveraged buyout.
Be transparent with your key financial partners, including your bank and bonding company, as they should be kept in the loop with your transition plan. Your financial partners will understand and benefit from a detailed transition plan. The company needs to maintain healthy financial ratios and the necessary working capital, but it will look different as money is transferred to the owner in the buyout.
Get the new management, especially the comptroller, engaged with your financial partners. Banks and bonding companies depend on the owner’s personal guarantees, which will have to be transferred to the new owners near the end of the buyout.
The company associates are your key asset. Leaders put the company, customers and associates first, not themselves. Promote the best people in the right chairs for the company to perform well. The empty chair must be replaced with a person of integrity.
Succession is key. The management’s performance is paying the owner. The managers must get to the next stage by growing and performing as champions. During this time, they must begin to think like owners and always put the company first. This will enable them to move into leadership, deal with their blind spots and put their associates and teammates first.
Succession takes time. It is a continuous process, not a single event. The process is about talent development rather than the typical replacement of talent. Teach, mentor and stretch your best players with training, progressive responsibility and leadership development.
In conclusion, exiting your business should not be taken lightly with as much is at stake. For many owners, the business can be their largest single asset and the primary source of retirement funds. With so many moving parts, including government-induced sales price erosion, a carefully designed exit plan should help overcome many barriers. Start early and implement slowly. In this process, time can be your best friend.