In the film Dead Poets Society, Robin Williams plays a gifted and dedicated teacher in a school with a long and distinguished tradition. In one scene, he takes his class of boys down to the school entrance hall, which is decorated with photographs of all the young men who have passed through the school over the years. He stands his class in front of a photo of a year group and asks them to imagine what words of wisdom these young men – all now long since dead – might pass on to them from across the years. As they lean forward to try to imagine what their predecessors might say, Williams whispers the words: “carpe diem,” seize the day. That phrase captures a major theme of the film: not to let opportunities pass by, to make the most of your life, seize the day.
This is also true for all those ambitious professionals and managers within organizations who initiate a buyout of a company or division. They are taking control of their lives and their destinies. With most companies now needing to get their houses in order, exiting opportunities are arising for managers across Canada and in almost every major industry. The transition of moving from corporate management to an entrepreneurial lifestyle is not for the faint of heart. Being an entrepreneur is the highest form of life. However, you must seize the day and clinch the deal.
We can all be tempted to live in the future. Perhaps we long for escape from the boredom or drudgery of our lives, perhaps to escape from an unhappy, unchallenging and limited career growth work environment. The challenge is not to wait for the future for things to get better, but to allow today or very soon becoming your first day as an owner as opposed to a worker.
However, we must separate the real “entrepreneurs” from the “dreamers.” Amongst a group of ten young managers or professionals, statistics tell us that only one has what it takes to be an entrepreneur. The rest just talk a good game. What separates the entrepreneurs from the dreamers is the ability as individuals to “invest” or “pledge” somewhere in the vicinity of $250,000. This number can be as high as $1,000,000 in some of the larger deals. Investors need to know you are committed.
Working partnerships of more than four are generally suspect. Private investors who will personally support the management team or make a company investment are greatly encouraged and almost always required. Institutional investors request private investors that have some management background or special knowledge to co-invest with them. Institutions refer to these investors as the “smart money.” If something goes wrong or an important decision needs to be considered, the institutional investor wants to have some other intelligent investors part of the deal, beyond the management team to help them work the issues out.
If you want to own something, you have to put your money and likely your job at risk. If you are unable to put your money on the table, stop dreaming. Some dreamers believe in a concept called “sweat equity.” This form of ownership is usually offered to current shareholders and owners that have an opportunity of “earning more or being granted options” on additional equity ownership usually based on future performance. People that put nothing on the line, usually get nothing.
Since most management buyouts are leveraged acquisitions, most will need to know the following. The prudent use of leverage can create exceptional returns to equity investors by satisfying the purchase price with borrowed funds in addition to their own equity. Typically funds borrowed have a much lower cost than equity does, and additionally, the interest components of the cost of debt are tax deductible thereby further lowering the cost of funds. The net effect is that the value of the equity grows inversely to the reduction in debt, thereby significantly increasing the return on the initial equity investment.
To ensure the success of a leveraged acquisition it is extremely important to establish an appropriate capital structure. Having a professional assist in the process is strongly encouraged by all sides. Your advisor will need to understand and present your written business plan detailing seasonality, cash flow cycles, capital expenditure requirements and other such factors. And regardless of such factors, only certain types of business are good candidates for a leveraged buyout. A list of preferences presented by lenders when financing a LBO is:
- Most industries, except for high-tech and those with rapid product obsolesce. Transportation is hot at this time.
- Companies that are not highly cyclical and which have steady predictable cash flows.
- Low capital expenditure requirements resulting in high free cash flow.
- Growth businesses, especially high valued added manufacturing, or with proprietary or sophisticated engineered systems or processes.
- Companies with strong committed management teams and well communicated, compelling business plans.
For those unaware, management buyout opportunities present themselves often and for a number of different reasons. The first and most common reason is that a company or division no longer fits within the strategic aims of the parent group or owner. Another reason may be that the parent group or owner simply requires liquidity or cash. Or, profit levels may not be considered acceptable, or the company is showing a loss. Other reasons are that a private owner wants to sell his business and not bother with the complicated process of selling to an outside buyer. Usually this seller has a very good relationship with the management team and has confidence in their ability to manage the business beyond. This type of owner usually retains some equity ownership or assists in the financing the business with vendor take back notes. Today, we are seeing opportunities in the government sphere, where a business or functional unit will find itself in the process of privatisation. (I.e. Liquor Control Board of Ontario retail outlets.)
It is encouraging to know that from the corporate perspective, management-led buyouts are generally regarded with great favour. They provide corporations with a convenient alternative to the acquisition of their company by an outside suitor, while at the same time allowing them to avoid the conflicts that often arise between management and outside buyers. A management buyout can be also be conducted more quietly and efficiently than a sale to an outside buyer or investor group. An of course, the prospective managers do not need the same warranties or detailed due diligence investigations than an outsider would.
So if the proposal and approach is serious and the management group has consulted with the appropriate professionals, the potential for a deal become excellent. Investors also depend on the fact that the vendor will assist in the financing of the transaction. Vendor Take Back Notes are very common in any and all management led buyouts.
With all this good news, unfortunately there are significantly more buyers than sellers at the moment because of the number of corporate buyers, financial institutions, merchant bankers and high-net worth investors on the hunt for good potential company acquisitions. Most of these groups usually are seeking management partners. Structuring a deal can be tricky. Not every deal is going to be accepted by the owners. Some deals can not be financed by management led buyers.
So why are there not more management led buyouts taking place? Are Canadians averse to risk? Not really. The entrepreneurial spirit is alive and thriving in Canada. Unfortunately, man people want to do it, but can’t. Most people do not realize that a slush fund has to be established by the management led group to cover legal, accounting and other advisory fees without the potential of a deal being done.
Sometimes careers can get lost in the process when an inexperienced team decide to approach their parent companies themselves. This approach can be disastrous. Sensing a mutiny in the making, some large corporations have dismissed top-level managers without even listening to their proposals. And even when they do, many deals are lost because of high running emotions that turn negotiations into a protracted and often traumatic process. For this reason it is important that management agree that they have an arrangement amongst themselves, (infighting is another reason deals fall apart), and that they enlist a professional and experienced intermediary. This professional will help package the opportunity, set up the process, structure the buyout deal, and negotiate with financiers and ultimately the owners. And let’s not forget the legal, accounting, tax and other levels of expertise that need to be integrated into the deal.
Maybe it is a fluke in the business cycle, but never in the history of time has there been more diverse, abundant and less expensive investment capital available chasing too few deals. There is no excuse for talented management teams not to take hold of their future and at least attempt to do a management buyout. Seize the day; use the opportunity of the present moment to pursue your vision.