Concepts Fund Raising Playbooks

Management Buyouts : Love ’em, change ’em, or make ’em leave

As a regular person in the start-up world, you don’t think too much about restructurings, leveraged buyouts and all the likes. So it is easy to also not think too much about management buyouts. You always think that you have a few founders, eventually they will step down or they stay on as key execs. They are acquired by a strategic, merged into a buyer or exit to public secondary or go bust. Right? You expect that all those good investors are pushing the company towards a traditional exit and all that.

Wrong! Statistically, MBOs or Management Buyouts are not too uncommon. And they do make sense. But first of all, what are management buyouts? It is not only founders buying their firms back – which it also is and includes -, but also executives that buy the founders and investors out. Or it is employees buying the founders and investors out using new investors. There are many cases.

In all cases, the management – whoever that might be – is (a) an insider that has information on the viability of the company, (b) believes to have a plan that works for the company, and (c) believes that either investors or founder’s are driving the company into a less attractive direction.

So it is failure of the powers that be, a strong conviction to know it better, a strong conviction that one is able to steer the ship, and a strong believe in an attractive price that is maybe not visible to external investors.

And there you go. You make up your mind.  How do you move on?

First of all, as managers, you have a conflict of interest. Let’s assume you have a business plan for the company that will outperform against the current one. If you head for MBO, are you not neglecting your duties as current manager? Should you not propose it? Lobby it? Push it forward? Yes you should. But sometimes, the others in charge of the company are not to be moved by your proposals.

It is a control game

In the end, you don’t want to buy out the shareholders. But you want control. The entire opportunity only starts to emerge if there is someone in management above you that is blocking the right path.

The first step is to get the shareholders behind you. Start a proxy war. Get the guy / gal above your out. Mmh. Won’t work in some cases. Maybe that indidividual is majority owner. Then no option remains but to do an MBO. But it is also harder to get it done. But the price to be paid will be higher. The person in charge usually doesn’t want to leave the seat.
In the other case, the majority is not in the hand of this individual. But there is a strong support for him. If the investors are institutionals, it is only about having a good enough businss plan, a plausible credibility as chief of management. But typically, it doesn’t work because you won’t have this credibility.
Hence the goal is to get the shareholders you can buckle behind you, and buy out the shareholders you cannot get behind you by giving a good price. But then, unless company is publicly traded, there will be trade restrictions. And the price quote will require others to participate in this, too. More money needed. But in theory, if price is high, the institutionals must move under fiduciary duty. The believers back you. Etc.

But it can become more and more tricky untll you reach a point where you have to force an exit event that makes everyone happy and you buy out the entire shareholders.

So the complexity can go quite high. And the cost associated go up, too.

And a financing the war chest game

Now, if you are a start-up, it’s still hard to go fully LBO. Leverage will be low or zero. Maybe some assets to use as backing. Maybe accounts receivable and unrealized bookings from existing contracts. Etc. That’s it.

Unlikely that you will get your own money to pay everyone out. So you will talk equity investors. Depending on the strength and plausibility of the business plan, and how you structure the investment, you might get some mezzanine in. With that you might get some venture debt in. You don’t know.

Luckily, there are many options. And yes, there are even specialized management buyout firms that support finding the financing and investor base to finance such a transaction. There are even venture and growth funds that put a bet on these games. There are the ones that help you get the executives. So there is an ecosystem.

Structuring the deal 

With all that said, are you buying out the shareholders and take control. Or is it wiser to sell the assets and liabilities of the company to a new vehicle. What is the tax impact? What is teh marketability impact? Is the current company marketable? How does the history look like? Any major fuck ups?

Are you paying all cash? Can you pay old investors with sahres in the new company? What about rights of those shares? Can you take the control rights?

Lots of considerations, here, too. Just thinking outside of the box is important.

Finally

Before transgressing too much. MBOs are not too uncommon. They do happen. There are players in the market that help. It can happen with old investors, with new investors, with special situations investors.

If it isn’t just a false businss plan, but also bad governance that was riding down the old team, structuring also can be a big part. It isn’t only about control and business plan. And changing management and buying people out.

And my assumption on the market is, this should not be too uncommon. There are likely lots of early stage start-ups that fucked up right here. And building portfolio strategies on these kind of special situations can be smart.

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