Dillon-MA

Management Team Buyout

This article appeared in the 2002 January issue of the LBM Journal!!!

Passing the Torch to Managing Executive(s)???

You want to retire, but that 'just right' buyer has not been found. Have you considered that the buyer may already be in your organization, a management person or your management team, maybe a customer or possibly that eager sales person who calls on you? The Management Buyout Plan is a plan that makes the owner a lot of money while generating funds for a management team to buy the business. The plan is designed initially for the building material industry to develop management minded personnel who would normally not be consider, into the ideal buyer of your company. This person or management team can realize and pay more for the goodwill of the company, as they will retain the customer base. An outside buyer, particularly a consolidator type buyer, will discount the goodwill knowing they will lose a portion of the customer base.

Two years ago a lumber dealer called wanting to sell their business. After review of the company records it was pointed out that the cash flow of the company would not meet the debt service for a buyer to acquire the company. At this point, the business was un-salable at a price that would meet the owner's goals. Further discussion disclosed that his targeted retirement was five years away. A customer had made an inquiry about buying the company, but the high asset base of a building material business had ruled this prospect out. This customer prospect did not have adequate funds for the down payment. The Management Buyout Plan was implemented, the owner designates funds (usually 50% of the profits over and above the three year average of the existing business) to be allocated for the Managing Executive(s) to establish an equity position (down payment) to buy the company. Today this prospect is the Managing Executive and the plan is in effect. The timetable is on schedule to meet the owner's goal of five-year retirement, as is the cash flow to meet the debt service. What is happening is the business is increasing in value six to eight times the amount being established in the Management Buyout Plan account. The executive, with down payment funds, now buys a more productive, more profitable business using only the additional profits of the business for the purchase. The owner has a greater value in the business and will receive proceeds in cash. Business conditions and enthusiasm of the executive(s) will dictate the length of time required to carrying out a given plan. Under the ideal situations it can be carried out in two years.

The Basic Idea without specifics: The plan is designed to build equity through motivation, while providing a business owner with the option to transfer the business to a Managing Executive that may be a family member. Since the Managing Executive(s) may not have the funds for a down payment initially, this plan accumulates funds in a Management Buyout Plan account for future down payment. The account is tied to an employment agreement and is funded as the Managing Executive(s) helps the business grow to new and higher levels of profitability. The plan is based on a percentage of profit, usually over and above the existing profit. The plan might compensate the account more aggressively when the business exceeds projected profit levels. The Executive(s) receives a normal wage and builds equity for the future purchase of the company. The owner's cash proceeds from the sale of the business can be invested in stocks, bonds or instruments of this nature with all tax deferred.

The employment agreement must be written in such a way that the present owner retains complete control of the funds. If terms of the agreement are not met, the contract becomes void, and the Management Buyout Plan account becomes the owner's asset. On the other hand if that 'just right' buyer comes along and the owner chooses to sell the company the value of the Management Buyout Plan account goes to the employee(s).

This establishes a win-win relationship for everyone involved and a rewarding incentive to improve the company at all levels. The exact percentages are tailored to each situation. The Executive(s) has an incentive to act, think, and plan as an owner. He/she knows that his/her efforts in improving the company are a direct personal benefit with the opportunity to acquire the business. The uniqueness of the plan increases the value of the company $4 to $6 for every $1 invested in the MANAGEMENT BUYOUT PLAN. The owner(s) becomes free to travel, meet their dreams in partial retirement, or to begin what ever they plan to do the rest of their lives. A Minnesota Company with sales in the $40 million range, using a similar ownership incentive plan, was able to increase the gross margin by two percent and sales by 14 percent in one year, simply by having more motivated personnel impacting the business. This increased profits by $760,000 and increased the business value in the range of $2,000,000.

This plan is initiated with a Market Pricing Analysis (MPA) of the company to establish the company's current market value and profit base. The Management Buyout Plan advisor coordinates an enhancement plan (business plan) with the owner, managing executive(s) and company advisors, this plan is reviewed quarterly for compliance. The advisor team usually consist of the Management Buyout Plan coordinator, attorney, accountant, financial planner, insurance agent, etc.- At the end of each year the plan is updated with a MPA to measure the growth and progress of the project. The annual MPA is reviewed with the owner(s), executive(s), and advisors, before finalizing the next year's activity plans. This can be done in a face to face meeting, but more often in a conference call. The year-end review will include keeping close tabs on the revenue to pay debt service, often referred to as EBIT-DA (Earnings Before, Interest, Taxes, Depreciation and Amortization), as it relates to the future purchase of the business. A business's value is strongly tied to the verifiable EBIT-DA. Proving what the business can generate is of critical importance to lenders who provide funds for the acquisition, enabling the owner to receive cash for the proceeds.

The most powerful ingredient in the plan described is the coordination, education and training of the entire staff, from the newest employee to the owner(s). In addition to the review mentioned earlier a well-run company will hold weekly staff meetings. The current owner(s) is transferring day to day operational knowledge and responsibility to the future owner(s) and the employees during the weekly staff meeting. The advisory team-the owner, attorney, accountant, insurance agent, financial planner, and Management Buyout Plan advisor - are constantly in touch with evolving business strategies to minimize taxes and maximize equity for the company and the Management Buyout Plan account. The Management Buyout Plan tax strategy will typically save a minimum of ten thousand dollar per year.

This plan is designed to include life insurance on the owner to provide funds for buy out, in the event of an untimely death. In addition the Managing Executive(s) insurance will provide protection to the owner against loss in the event of accidental death of the executive(s). Death of the key employee could result in losses should the owner be required to sell at a large discount or liquidate the business in order to retire.

At this point in time, you might be asking yourself, “How can I afford NOT to motivate my employees with this type of plan?” The answer: You can't.

The plan described can adapt to any size building material business or industry type as long as consideration is given to fit the goals of all parties. There is little or no down side to having a Management Buyout Plan option of selling the company to Management Personnel. In the event that a 'just right' buyer appears provisions have been made in the employment contract for the employee(s) to receive the value they have been a part of creating. A win-win equation that elevates an average company to a high performing, well run entity.

It is important to keep as many options open as possible for whatever the future holds. Failure rarely occurs because someone has too much knowledge or too many options.

There is great opportunity for independent building material owners and their successors when a well-organized secession plan is in place for a business. Things go more smoothly by design than when they happen by default. Proper planning for the future will assure the continued growth of the business and opportunities for the business successors. An M&A Specialist firm can establish a plan to fit your business, adding value, minimizing taxes and costly mistakes. Transferring your most valuable asset-your business-to a new owner is part of the owners responsibility to, family, their retirement and an important part of the owners legacy to the company they created.

Ron Dillon is a Merger & Acquisition specialist With Dillon Group, Ltd. in Lenexa, KS
(913)888-8001
rondillon@dillon-ma.com

Note: The article was published with the plan name MESOP™. This tended to confuse people as it too closely resembled ESOP the plan name has since been changed to “Management Buyout Plan”.

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