Executing Management Buyouts or Intergenerational Transactions

Selling your business to your management teams is not dissimilar from the process of selling your business to the next generation of your family. Our mission is to help you achieve a successful sale while ensuring your financial and non-financial objectives are met.

Ultimately, our clients make all the decisions, but leverage our financial expertise, deal experience and market knowledge every step of the way. 

This article discusses the steps involved with selling your business to management or to the next generation. If you haven’t yet prepared for a sale, refer to our blog posts about preparing your business for a sale or succession planning.

Selling your business to a family member or existing management team can be a great way to ensure a lasting legacy for your business with a known party having similar values. The challenge with any internal succession plan is balancing the price and terms a business owner could ultimately receive in the open market against the lack of financial resources typically available to a young management team or the next generation.

It’s important for business owners to understand the tradeoffs associated with an internal succession plan. In some cases, this might be a possible discount on the price that would be obtained in a sale in the open market. In all cases involving deferred consideration (discussed below), the risk of receiving payments is directly tied to the ongoing success of the business which may no longer be under your control.

Here’s a breakdown of the key considerations involved with executing a management buyout or intergenerational transfer.

Start Communicating Early

Business ownership is not for the faint of heart. As a business owner and leader, you need to have a pulse on what your management team or children are capable of in terms of assuming your role and leading the business forward. Are there any skill gaps that need to be addressed? Do they have the intangible qualities and grit to ensure the business succeeds long after you’ve exited? Young leaders will not “have it all” but you have likely identified individuals that have high potential.

If that’s the case, the next step is to communicate with the next generation/management team about whether they are interested in all the risks and rewards of ownership. As noted, ownership is not for everyone, therefore it’s important to have clarity of whether there is mutual interest in exploring a possible transition.

Financial Considerations

Assuming there is mutual interest in exploring an internal succession plan, it’s important to understand all the relevant financial matters.

For the existing business owner, this includes:

  • Evaluating your cash requirements in retirement with the help of your accountant or financial advisor.
  • Understanding the fair market value of your business. Consider engaging an independent business valuator to remove bias. This is especially important in intergenerational transfers from a tax compliance standpoint, or if there other family members that are expecting an inheritance from the sale of the business.

For the management team or next generation, this includes:

  • Evaluating the amount of capital available for a down payment on acquiring the business. From the standpoint of the business owner, you want your successor to have meaningful “skin in the game” so this expectation should be made clear.
  • Evaluating the amount of debt a bank is willing to provide you to acquire the business. This might require preparation of a financial model and financing proposal for a lender to evaluate. The financial model and financing proposal should present the specifics of the business plan and transaction, the historical financial statements and trends, and a three-to-five-year forecast that illustrates the prospective cash flows and debt servicing capability of the business. Lenders will typically leverage this model during their underwriting process.

When and How?

Depending on the circumstances, the parties might decide they’d like to do a clean transition for 100% of the business on day one vs. a partial transition of the business over a number of years (e.g., 20% of the business per year over 5 years).

Once there is alignment over the timeline, price, and the amount a business owner is able to receive on closing, there will likely be a shortfall from the fair market value of the business. This shortfall is often addressed via a vendor takeback and in some instances an earn out, which are essentially deferred payments with terms and conditions.

Both parties should engage legal counsel familiar with internal succession transactions so that the legal agreements reflect the intention and interests of both parties.

Concluding Thoughts

An internal succession plan is a great way to ensure that your business continues with the same culture and vision that you have likely spent decades creating. It also rewards family members or employees that have been loyal to the business for many years. A thoughtful approach should be taken to ensure that the tradeoffs of an internal succession plan vs. a sale in the open market meet the overall objectives of the family.