When Does A Management Buyout Work Best

Posted on: June 14th, 2021

Many management teams see management buyouts in a salvific light. If only we owned the business, we could make better decisions and grow in new directions. While it is true that longstanding owners tend to be more conservative, an ownership change to management needs several additional factors to be successful. The changing of the ownership guard does not by itself ensure scale-up certainty.

Planning a Management Buyout

The management buyout must be well conceived, structured and capital supported. The growth plan needs to be carefully developed and agreed upon well before closing. Post-closing operational execution needs to be mapped out clearly beforehand along with a clearly delineated authority structure. Capital adequacy and growth plan quality are the two biggest drivers of management buyout success. If the deal is struck at an advantageous price for the buyer, and there is less pressure to pay all the price up front, the management team is well positioned. This reduces the amount of cash needed to pay at closing, giving the team more room to bring in critical growth capital to turbo-charge the growth plan.

If the price is too high and its paid all-in cash, management usually does not enough extra capital to kickstart the growth plan. This leads to an inability to invest in new areas, leading to a slow growth and ultimately a slightly overleveraged company. Under this scenario, management can service its debt and capture a return from deleveraging, but it lacks the cash to embark on its transformational growth plan.  Sometimes management teams overestimate their value to the Company relative to the prior owner.

Ownership tends to have a very deep understanding of the market and the Company’s market position, built up over many decades of history. While the owner may not have the specialized functional expertise of the management team or their enthusiasm for growth, they usually are more grounded as to why fast growth is not possible. Management may be overly excited about growth based on naïve enthusiasm. The key determinant of the ability to scale rests on management’s conducting thorough commercial market due diligence.

Management must gauge the size of the market, the other competitors, and the obstacles to penetration. They must make sure this commercial market diligence is translated down to an action plan level that is easy for them to execute post-close. Finally, they must understand how much time and capital is needed to make this new growth possible. When management teams align both a strong purchase price with a market tested growth plan, their management buyout is well positioned for success.