Employee Buyouts

If you are a business owner who has sold your business to an employee who wants to take over your business, you may be familiar with the term employee buyout. In its simplest form, an employee buyout allows a management team to pool resources to acquire part or all of the business it runs. A leveraged buyout is based on the same principle, except that buyers use the company’s assets as collateral to obtain financing. In most cases, the management team takes full control of the business and relies on their expertise to make it grow. Both of these types of business takeovers, which can be large in scale, are usually financed with a combination of personal funds, investor funds, and owner funds.

Benefits of MBOs

There are several advantages to these recovery methods for everyone involved. Most obviously, they allow for a smooth transition. Since the new owners are already familiar with the business and its operations, there is less risk, and other employees, customers, and business partners are reassured. In addition, the internal process and transfer of authority remains confidential and is often completed quickly. Once the business owner agrees to transfer or sell their business to staff members, a series of common steps associated with the transfer of authority are usually adopted.

The typical process is as follows:

• The valuation of the business sets the agreed price.
• The employees estimate the portion of the shares they can acquire immediately before drafting the shareholders’ agreement.
• Financial institutions are approached.
• A transition plan that incorporates tax and succession planning is developed.
• Employees acquire the seller’s share through financial support.
• Decision-making and ownership powers are transferred to the successors. This can take place over a period of months or even years.
• The employees repay the financial institution. Repayment is made according to a schedule and at a pace that will not slow down the company’s growth too much.

Buyers must ensure that the project is profitable or at least has the potential to be profitable. Keep in mind that a buyout requires significant funds, which will impact the company’s cash flow. To offset the cash outflow required for repayment, buyers will need to adopt a strategy to increase cash flow, such as reducing expenses, improving productivity, or increasing revenues.

A comprehensive financial analysis should reveal cash flow, sales volume, debt capacity, and growth potential. This analysis should also provide important information about the fair market value of the business and management’s latitude to manage.

How to Prepare for an Employee Buyout?

The buyer(s) will need to develop a solid business plan to properly prepare for the acquisition. Forecasts must be credible and realistic. Personal and business contacts and references can also help a successor gain the confidence of bankers. For a small business buyout, one financial institution is usually sufficient to finance the project. For larger transactions, several institutions may be involved in the financing.

In a leveraged buyout, the assets of the business are valued to determine the equity available for financing. The lender will use the assets as collateral. The financial institution will set the interest rates based on the risks involved in the transaction.

The lender may ask the seller to finance a portion of the sale to demonstrate their commitment to the project and their confidence in the management team. Be sure to shop around for the best terms with financial institutions.

How to Finance a Company Takeover by Employees?

Here are some basic types of funding that can be combined to make your transition successful:

• Personal funds are used to gain the confidence of a financial institution, to increase the equity in the transaction, and to share the risk. Buyers are often required to invest a significant amount of their own equity, including refinancing personal assets, to prove their commitment.
• Bank loans or credit notes are often used to purchase the shares you own in the company. This type of financing is attractive because of its simplicity: assets are used as collateral and interest rates are lower.
• Seller or owner financing allows you to spread out payments over a number of years. This type of financing ties you directly to the property and may include credit notes, loans, or preferred shares. This method reduces the cash outflow at the time of the transaction and eases the transition.
• Similarly, the purchase of shares payable in installments allows the seller to maintain a level of control until it has been fully repaid.
• The sale of shares to other employees can be used in conjunction with a buyout by a portion of the employees or a leveraged buyout to finance the remaining portion. This type of financing allows other employees to purchase stock options in the company. This type of financing can motivate existing employees while the management team retains control of the business.
• Subordinate financing can complement the management team’s equity investment by bringing together some elements of both debt and equity financing without diluting ownership in the business. If a profitable business maximizes its asset financing and the management team’s personal funds are insufficient, the institution providing the subordinate financing may agree to assume a higher risk to participate in the project. Repayment terms are established at the time of the transaction.

Employee buyouts can be an attractive option for business owners looking to retire or transition out of their businesses. By following a rigorous process and obtaining the necessary financing, employees can take control of the business and continue its growth and success for years to come.