Step 5: Strike a deal with an equity investor. If the deal closes, the cost of doing the MBO -- including the accounting and legal fees and the money paid to the buyout firm and banks -- usually comes to 3% to 5% of the sale price, which is added on top. That means that in a $50-million MBO you have an additional $1.5 million to $2.5 million to pay off. (If the deal falls through, the buyout firm traditionally eats most of the costs.) Plus, in a deal of that size, the buyout firm might take a $150,000-a-year management fee.
What would the buyer and new CEO get? Fifteen percent of the company is the middle of the range these days, and it could come in the form of stock or stock options that usually vest over four years. Managers could get a bigger piece if they put up some of their own money. Buyout firms like Rickertsen's generally insist that they do.
"It's really important for me that you have some skin in the game. It doesn't have to be a ton, but it has to be something that's meaningful to you," says Rickertsen. "Some managers can cut a check for $250,000 to $500,000. For managers who don't have a lot of liquidity, we ask them for $15,000. Some buyout firms like it to hurt. They want you to be very leveraged and very focused. We don't believe that's the right answer, because managers may be prone to taking short-term draconian actions that may impact the company longer term. But I want you to write a check, to show that you're there alongside me."
What can go wrong during Step 5? Even after writing the check, you'll have a minority interest in the company. The board, which will be handpicked by the buyout firm, will control everything, from the decision about when the company will be sold -- within three to five years -- to whether you'll keep your job.
Buyers need to think of the deal they make with their equity partners as a marriage, and they need to be candid with one another up front, Rickertsen says. If your equity partners don't tell you up front what the conditions are under which they might make a management change, ask them. There probably won't be a lot of negotiating room there, but you can do some things to protect yourself. Rickertsen suggests being very specific by saying something like "If you fire me in the first year, 25% of my equity should vest." And a year's salary as severance is not out of the question.
As part of such discussions, spend a lot of time on exit strategies. The buyout firm will want to be out of your business within five years, but you may not want to be. If you pick the wrong buyout firm, you can be in for a lot of unpleasant surprises. Don't shortchange this step.
Step 6: Arrange bank financing. From the buyer's viewpoint, this is the easiest part of the process. You don't do anything. The buyout firm has a list of banks it works with, and it does the deal.
What can go wrong during Step 6? "There's a real credit crunch going on," Rickertsen says. "The banks have been burned in some large buyouts. They lost a lot of money in the telecom and dot-com worlds. So banks have been pulling back aggressively since about October. Today you can only borrow 2.5 to 3 times cash flow. Before the crunch, you could have gotten 4 or 4.5. That means you have to be tougher on price, and your partners need to be prepared to put in more equity."
Step 7: Complete the due diligence.
What can go wrong during Step 7? Contracts with key customers that you thought were bulletproof aren't. There are expenses that haven't been accrued. You might find litigation bombshells.
Step 8: Close the deal.
What can go wrong during Step 8? Says Rickertsen: "In 30% to 40% of cases, you have an 11th-hour heart attack."
Step 9: Build the company.
What can go wrong during Step 9? In the venture-capital world, out of every 10 deals, "2 are screaming home runs, 3 flame out, and 5 are the walking wounded where you'll probably get your money back," Rickertsen says. "With private-equity deals, which involve later-stage companies that already have income statements and balance sheets, you probably have one to two deals that flame out. You have one that's a big home run because all of the stars lined up in a way that you could never have anticipated. And then you have six or seven moderately successful companies generating 15% to 25% returns on invested capital."
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