Buyout

Paul B. Brown is the author or coauthor of 10 books and editor-in-chief of DirectAdvice.com.

The Practice Formerly Known as ...

Management buyout?

If you're thinking that the process used to be described as a leveraged buyout (LBO), you're absolutely right.

Before we talk about why the name changed, let's first make sure we all agree about what we are talking about.

Here's the way Rick Rickertsen of Thayer Capital describes this type of deal: "Management buyouts (MBOs) are acquisitions of operating companies or corporate units in which the current or future senior management of the business participates as a significant equity partner in the acquisition."

As for the name change, blame Michael Milken. The term LBO has fallen from favor in an attempt to make people forget the excesses of the 1980s, when corporate raiders floated junk bonds to buy out companies -- a concept that Milken honed to perfection at Drexel Burnham Lambert -- and greedy financial types got a bad name for showing up at the aptly named Predators' Ball, where the raiders celebrated the fleecing of all they had come in contact with.

As Rickertsen writes in his book, Buyout: The Insider's Guide to Buying Your Own Company, "The term LBO is no longer used in the industry, or in polite company."

Say What?

Here are some terms that buyout firms frequently use and translations of what those terms actually mean, according to Rick Rickertsen.

Buyouts by the Numbers

A step-by-step primer on how a management buyout is done

There's no such thing as a typical deal, but here's how most management buyouts (MBOs) should work, according to buyout veteran Rick Rickertsen. (Note: What follows is a "straight vanilla" deal. There are infinite variations, including ESOPs -- employee stock ownership plans.)

Step 1: Be confident. "You can't have any doubts," says Rickertsen. "If you have doubts about embarking on a buyout, you just shouldn't do it."
What can go wrong during Step 1? The flip side to not wanting a deal enough is wanting it too much. If, say, you're willing to pay too high a price or want to buy something that's twice as large as anything you've ever run, you won't get funding.

Step 2: Find or create an opportunity. Identify how the company can make more money.
What can go wrong during Step 2? You can look too far afield. If you're working for a manufacturing company and you're thinking of buying one of the companies that sells your product, "that is going off-spec," Rickertsen says. "Retail is a different business."

Step 3: Develop a sound business plan. "You want to be aggressive," Rickertsen says. But you also have to develop a plan that's achievable and credible. If your industry is growing at 7% a year, say, and you claim that you're going to increase your sales by 30%, you're telling the world that you're planning to take market share away from other companies -- "and that is very difficult," says Rickertsen.
How you structure the business plan is crucial. Rickertsen's tips:

• The executive summary is key. You always suspected that if you didn't hook people on page one, you were doomed. You were right.
• Research is key, too. Your description of the market needs to be better than any other summary that investors can find on their own.
• Don't exaggerate. Never say you have little or no competition. Says Rickertsen: "The phrase means that either you're too dumb to recognize that you have competitors, or you believe the investor who's reading the business plan is too dumb to know better."

What can go wrong during Step 3? A buyout firm is going to hold you to your forecast. As Rickertsen puts it, "If you don't make plan, you're toast."

Step 4: Strike an agreement with the seller. In most cases, you want to avoid doing the negotiations yourself, Rickertsen says, since the process can be very emotionally charged. It's always helpful to have a "bad guy" around, like an accountant or a lawyer, who can negotiate on your behalf.
As for what you offer in the deal, Rickertsen has some interesting thoughts:
"You come in one dollar above insulting. Everyone has to negotiate," he says.
"When I started out in the buyout business, [I figured it would go like this]: 'You want to sell me your company? Here's my deal: $7 million. If you don't want to do that, forget it.' I don't like to haggle.
"What I learned is that everyone wants to negotiate. Everyone wants to win something. So you always come in lower than where you want to end up," he says. Say that a company is up for sale and the owner gets comparables indicating that it could go for anywhere between $7 million and $10 million. The investor offers between $6 million and $9 million. "I would probably come in at $6,375,000, for two reasons. One, because it's not insulting. And two, because it looks scientific," he says.
What can go wrong during Step 4? The parties involved in the deal can let their emotions carry the day. For instance, the owner could hear the comparables and say something like "Hogwash. Those may be other companies, but mine is special." The potential buyers, on the other hand, sometimes become so smitten with the thought of buying the company that they're willing to pay too high a price.