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Market Insight – Q3 2015 Leveraged buyouts & succession planning in Canada

Management Buyouts as an exit strategy
Succession planning for many small- and medium-sized businesses is often a secondary thought: the Canadian Federation of Independent Business estimates that only 40% of owners have addressed the issue and just 10% have a formal succession plan in place. This is a significant issue, as the baby-boomer’ generation nears retirement. Having a well-defined plan not only ensures a smooth transition but also maximizes the value that owners secure for their hard-earned success over the years.

One way to facilitate this succession is via a management buyout (MBO), whereby a company’s management team takes over from previous ownership by leveraging existing assets and operations.

In this issue of our Market Insights, we draw on reports by Deloitte, Abbott Capital, McKinsey and RR Donnelley.

Why an MBO vs. a company sale?
When planning a transition to new owners, many factors come into play and few are as contentious as 1) aligning vision, culture and long-term
objectives between parties, and 2) preserving the integrity of the firm (e.g. a desire to retain all employees in the current location).

A third-party, understandably, has its own set of values and goals and it may not be optimal for a buyer to keep the acquired company as is.

Instead of selling to a third-party, existing owners can invite their management team to buy into the firm via an MBO. Doing so addresses the two key issues identified above because management is typically far more aligned with existing owners than any third-party would be.

Furthermore, an MBO provides the lowest risk with respect to business continuity since the new owners already know the company, its operations and its employees and are now far more incentivized. This structure also safeguards confidentiality by keeping the deal internal and allows for a much shorter due diligence and transaction time frame. Arriving at an agreeable price is typically less controversial as well.

Enabling MBOs with leverage
MBOs usually require large amounts of capital relative to what the management team is able to contribute in cash. There are three main types of capital available to bridge the gap:

  • Term Debt: For healthy cash-flowing or fixed asset-rich businesses,
    banks and other alternative lenders can provide term loans.
  • Equity: Term Debt is typically capped at 3 – 4x TTM EBITDA in the
    lower mid-market. If the purchase price is higher, equity injections
    may be required from management or alternatively a private equity
  • Vendor Take Back (VTB): Alternately, or in combination with equity,
    the seller may opt to help finance the purchase by extending a loan
    to the management team.

MBOs require strong underlying cash flows as well as some level of fixed long-term assets to support the new interest and principal repayments. Junior or mezzanine debt providers can stray somewhat from these requirements but their involvement comes at an additional cost. And it goes without saying, financing a transaction with debt introduces the risk of default.

Why not always do an MBO then?
Most of the time, strategic buyers can pay more than a management team because strategics can generate cost and/​or revenue synergies with their current operations. Therefore, if the primary goal of existing ownership is to maximize cash in their pockets and they don’t mind what the company looks like post-transition, then a sale to a strategic may be more beneficial.

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