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What is a management buyout?

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2015-12-26 02:56:46

Leveraged Buyouts and Management Buyouts Private equity firms

like the Carlyle Group, Kohlberg Kravis Roberts (KKR) and many

others have made huge returns for investors through buyouts. Using

financial engineering and a lot of debt these firms buy companies

with little money down. While these types of transactions create

spectacular returns for investors, they often shortchange the

seller and management teams that drive the business. Thankfully,

owners and managers can use these same financial tactics to buy and

sell their business and have the benefit accrue to them. How Most

Buyouts are Done Private equity firms do hundreds of buyouts a

year. Their typical approach is to offer to buy a controlling stake

in a company using leverage they obtained from banks based on the

financials of that company. Often times these firms commit very

little of their own money to purchase the business. With little

cash invested, these deals create spectacular returns for the

buyout firm. Buyout firms also collect large fees up front, as well

as additional advisory fees while operating a company they've

acquired, and a big share of the investment profits. The average

annual management fee to do business with a private equity firm is

about 1.5% to 2.5%. The average share of profits is about 20%.

While buyout firms give management ownership, it's usually less

than 20% of the company. This type of buyout is the most common and

is typically called a Sponsored Leveraged Buyout, where the equity

player is the "Sponsor." Non-Sponsored Management Buyouts For

financially healthy businesses, there is another approach that

utilizes the same financing techniques but management gains

operating control. In fact, management can end up owning 85% to

100% of the Company depending on the situation. These types of

buyouts are called Non-Sponsored Leveraged Buyouts. Keys to

Non-Sponsored Buyouts The process of completing a non-sponsored

management buyout is pretty much like any other kind of business

financing. The key requirements for a successful non-sponsored

buyout include: Quality Company and Team - An ideal situation is

for the buyer(s) to already be running a profitable business.

Common situations would be a CEO that buys a company from a passive

owner or a limited partner buying out his or her majority

partner(s). The key is for would-be lenders or investors to have

confidence in the management team once the owner walks about the

door. Our experience encompasses helping managers and minority

shareholders execute non-sponsored buyouts that realize control of

the business while allowing them to create significant value.

Proactive Management - Many prospective buyers never ask for the

opportunity to buy their owner's business. Many are reluctant

because they are unfamiliar with the process or believe they can't

qualify for financing. Interestingly, it's the financials of the

company, not the individuals that drive the ability to perform a

non-sponsored buyout. The best way to start such discussions is to

informally ask if the owner is open to discussing it. Once you get

a 'yes' (even a tentative 'yes'), more homework can begin.

Agreement on Purchase Price - Agreeing on a purchase price can be

as complicated or as simple as both parties want to make it. Still,

most small to mid-sized companies are valued at a multiple of

between 4 to 7 times cash flow (commonly called 'EBITDA' - for

earnings before interest, taxes, depreciation and amortization). As

an example a company that makes $2 million a year EBTIDA would be

worth $10 million at a 5 multiple (5X). Knowing this, the most

direct way to get a price is to ask the owner their price. Any

purchase price within a 4 to 7 range will probably work. In fact,

our experience has shown buyers will end up owning more through a

non-sponsored buyout than a sponsored buyout even if they have to

overpay some in order to buy the company. Understanding of

Financing Options - Most companies know they can get debt from

banks and equity from buyout funds. However, a there are a variety

of lesser known funding sources such as subordinated debt lenders,

insurance companies, corporate development companies, hedge funds

and other specialty lenders that will lend beyond a traditional

bank. These are the same institutions that buyout firms use.

Depending on the economic climate many of these firms will lend up

to and sometimes over 4 times cash flow (EBITDA). uyout Math:

Putting it all together following the math here, if a buyer

purchases a company for $10Million (5X EBITDA) and can borrow

$8Million (4X EBITDA) they end up owning 80% of the Company. Owners

are satisfied because they get cash up front with no recourse.

Buyers like it because they get control. Also, most of these

specialty lenders do not require personal guarantees limiting the

downside risk to new owners. Over time the owner's remaining

interest can be bought out, often at a higher valuation. Most

important, the value to all parties is directly driven by the

buyer's performance rather than financial engineering by outside

investors. .

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