Management buyout: How to identify successors within your company

16 April 2024 by National Bank
A group of people shaking hands to close a management buyout agreement.

Transferring a business to current employees can be an attractive option when an entrepreneur is ready to hand over the reins. This is called a management buyout (MBO). Here’s what you need to know about MBOs and how to identify the best possible successors on your team. 

What is a management buyout?

A management buyout (MBO) occurs when a business is acquired by one or more individuals who are already part of the organization. Companies that do not have a family successor often opt for this type of transfer. By handing over the reins to a buyer or group of buyers who are familiar with the organization, the transition generally goes more smoothly.

How is a management buyout different from a leveraged buyout and a management buy-in? 

A management buyout (MBO) should not be confused with a leveraged buyout (LBO). The latter involves buying a significant amount of equity in a company and using the company’s assets to secure the loan. This form of acquisition is usually carried out by a team of external buyers or in partnership with external shareholders.

An MBO is also not the same as a management buy-in (MBI). In this case, an executive or a team of executives from outside the company take over the company.

Here are three concrete examples to help you keep them straight: 

  • In the case of an MBO, a team of company employees or managers acquires the business.
  • With an LBO, it’s a group of investors, a competitor company or a supplier that acquires the company without necessarily being involved in its operations.  
  • In an MBI, managers or individuals from outside the company buy a company.

What are the advantages of a management buyout?  

An MBO, or management buyout, has several advantages, both for the buyers and the acquired company. Here are the main ones:

  • The buyers are familiar with the company’s mission, its procedures, strengths and weaknesses. They are already very invested in the success of the business objectives.
  • An MBO provides better continuity for the company’s activities since the management team and/or key employees remain in place. 
  • An MBO also ensures better financial viability for the organization.
  • It can be reassuring for the seller that the company’s culture and values will endure.

How do you identify the right successors among your current employees?

The most important step in a management buyout is to select the strongest internal succession team possible. This can be a complex process that can sometimes frustrate potential buyers if not done carefully. The following key steps will help you identify the right candidates. 

Ensure that the owner is ready to hand over the business 

One of the first questions to ask is whether the owner is ready to step down. Is it the right time and are they actually willing?

While it may seem obvious, a lack of clarity on this point can have negative consequences for the company.

Let’s consider a real-life case: An entrepreneur identified his internal succession team and prepared them for the transfer during a process that lasted two years. The businessman then decided to give himself another year before relinquishing ownership. At the end of this period, he announced that he wasn’t ready to leave. As a result, the employees who had been identified to replace him left the company.

Good to know: A transfer takes proper preparation, but the entrepreneur must also respect their promise to sell. Failure to do so will create a sense of apathy and could trigger the departure of key employees.

Identify potential resources within the company 

Once the entrepreneur is sure that they want to transfer their business, they will need to draw up a list of candidates, based on criteria such as their contribution to the company and their potential to grow internally.  

Once you have this list in hand, you will need to hold discussions with the potential buyers in order to learn more about their skills, their professional aspirations and their interest in investing in the company.

Evaluate whether the people identified have an entrepreneurial profile

If the people on your list are interested in taking over the business, it’s necessary to assess whether they actually fit the profile. Psychometric tests exist that allow business owners to determine whether a potential buyer has strong leadership skills and is capable of promoting a positive and productive work culture.

Determine potential buyers’ risk tolerance 

Not everyone is cut out to be a business owner. One of the necessary qualities is a strong tolerance for risk. To assess whether they have this quality, you can ask potential buyers if they are willing to inject their own cash into the company should the need arise. 

Entrepreneurs can thus distinguish between an employee with an entrepreneurial profile and an employee with a shareholder profile. The former is ready to invest to make the company grow while the latter is more interested in the return they can get from the company’s performance.

Ensure that the buyer(s) have the support of their entourage 

It’s no secret that entrepreneurs have to shoulder a lot of stress. Having the support of those around them is usually a factor in their success. 

Business owners sometimes feel isolated and “alone at the top.” The support of their partner and family and friends becomes particularly important. That’s why buyers should discuss the opportunity with their loved ones and get their approval before acting on it. 

Additionally, when employees take over the reins of a business, they must also be able to count on their internal colleagues to foster collaboration and ensure business continuity.

What are the other important points to consider in a management buyout? 

The work doesn’t stop after you’ve identified your successors. There are other elements you need to put in place to ensure a smooth transition. Here are two. 

Prepare a communication plan

Announcing a company buyout is not a simple task. Transforming someone from a coworker into an owner is a sensitive process that, if done improperly, can provoke a negative reaction.

That’s why it’s critical to ensure the process is transparent so all stakeholders have a clear understanding of the various steps.

Managing perceptions about who is buying the company keeps employees engaged, confident and motivated for the long run. It can also prevent the departure of valuable talent.

Surround yourself with experts

A management buyout or any other type of business transfer is a complex process that requires careful guidance. Several external specialists in business transfers, such as tax specialists and your financial institution, should be involved. Don’t hesitate to get their input. They’re solid partners who will increase your chances of success. 

Find out how National Bank can help you transfer your business.

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