Lantern Capital Advisors helps
management and minority shareholders execute leveraged buyouts that
realize control of the business while allowing them to create
significant value.
Leveraged Buyouts
and Management Buyouts
Private equity firms like the Carlyle Group, Kohlberg Kravis Roberts and many
others have made huge returns for investors through buyouts. Using
financial engineering and a lot of debt these firms buy companies
with little money down. While these types of transactions create
spectacular returns for investors, they often shortchange the seller
and management teams that drive the business. Thankfully, owners
and managers can use these same financial tactics to buy and sell
their business and have the benefit accrue to them.
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How Most
Buyouts are Done
Private equity firms do hundreds of
buyouts a year. Their typical approach is to offer to buy a
controlling stake in a company using leverage they obtained from
banks based on the financials of that company. Often times these
firms commit very little of their own money to purchase the
business. With little cash invested, these deals create
spectacular returns for the buyout firm.
Buyout firms also collect large
fees up front, as well as additional advisory fees while operating a
company they've acquired, and a big share of the investment profits.
The average annual management fee to do business with a private
equity firm is about 1.5% to 2.5%. The average share of profits is
about 20%. While buyout firms give management ownership, it’s
usually less than 20% of the company. This type of buyout is the
most common and is typically called a Sponsored Leveraged
Buyout, where the equity player is the “Sponsor.”
Non-Sponsored Management Buyouts
For financially healthy businesses,
there is another approach that utilizes the same financing
techniques but management gains operating control. In fact,
management can end up owning 85% to 100% of the Company depending on
the situation. These types of buyouts are called Non-Sponsored
Leveraged Buyouts.
Keys to Non-Sponsored Buyouts
The process of completing a
non-sponsored management buyout is pretty much like any other kind
of business financing. The key requirements for a successful
non-sponsored buyout include:
Quality Company and
Team
–
An ideal situation is for the buyer(s) to already be running a
profitable business. Common situations would be a CEO that buys a
company from a passive owner or a limited partner buying out his or
her majority partner(s). The key is for would-be lenders or
investors to have confidence in the management team once the owner
walks about the door.
Our experience encompasses helping managers and minority
shareholders execute non-sponsored buyouts that realize control of
the business while allowing them to create significant value.
Proactive
Management
– Many prospective buyers never ask for the opportunity to buy their
owner’s business. Many are reluctant because they are unfamiliar
with the process or believe they can’t qualify for financing.
Interestingly, it’s the financials of the company, not the
individuals that drive the ability to perform a non-sponsored
buyout. The best way to start such discussions is to informally ask
if the owner is open to discussing it. Once you get a ‘yes’ (even a
tentative ‘yes’), more homework can begin.
Agreement on Purchase Price
-
Agreeing on a purchase price can be as complicated or as simple as
both parties want to make it. Still, most small to mid-sized
companies are valued at a multiple of between 4 to 7 times cash flow
(commonly called ‘EBITDA’ – for earnings before interest, taxes,
depreciation and amortization). As an example a company
that makes $2 million a year EBTIDA would be worth $10 million at a
5 multiple (5X). Knowing this, the most direct way to
get a price is to ask the owner their price. Any
purchase price within a 4 to 7 range will probably work. In fact,
our experience has shown buyers will end up owning more through a
non-sponsored buyout than a sponsored buyout even if they have to
overpay some in order to buy the company.
Understanding of Financing Options
- Most companies know they can get debt from banks and equity from
buyout funds. However, a there are a variety of lesser known
funding sources such as subordinated debt lenders, insurance
companies, corporate development companies, hedge funds and other
specialty lenders that will lend beyond a traditional bank.
These are the same institutions that buyout firms use.
Depending on the economic climate many of these firms will lend up
to and sometimes over 4 times cash flow (EBITDA).
Buyout Math:
Putting it all together
Following the math here, if a buyer
purchases a company for $10Million (5X EBITDA) and can borrow
$8Million (4X EBITDA) they end up owning 80% of the Company.
Owners are satisfied because they get cash up front with no
recourse. Buyers like it because they get control. Also, most
of these specialty lenders do not require personal guarantees
limiting the downside risk to new owners. Over time the
owner’s remaining interest can be bought out, often at a higher
valuation. Most important, the value to all parties is
directly driven by the buyer’s performance rather than financial
engineering by outside investors.
Lantern Capital Advisors works with management teams to evaluate a
company’s business and potential for a leveraged buyout. If it is
believed that the future of the business provides a
strong potential for success, Lantern Capital Advisors will work
with management to draft a letter of intent (proposal) to purchase
the Company from the owner. Often one of the biggest road blocks to
executing a management buyout is the owner’s belief whether
management is a qualified buyer. To gain the confidence of
management and the owner, Lantern Capital Advisors pre-qualifies the
buyout with multiple potential lenders/investors prior to submitting
a proposal to the owners so that both owner and buyer can feel
confident a deal can get done. Lantern Capital Advisors can also
help management and owner identify an independent valuation firm to
justify the purchase price both for the potential buyer and seller.
Once an owner accepts the letter of intent, Lantern Capital Advisors
will work with management to draft a business plan and financing
request to secure the needed capital. Lantern Capital Advisors
will arrange meetings with interested lenders and investors and will
assist with the negotiations of all financing proposals.
The goal is to find financing that optimizes management’s ownership
potential and long term objectives.
Once the financing is in place, Lantern Capital Advisors works with
the owners and management to monitor due diligence and close on the
purchase transaction. Lantern Capital Advisors can also coordinate
with legal and accounting professionals to optimize the structure of
the new company and purchase. This includes an analysis of a full or
partial ESOP structure for the transaction.
How Lantern Capital Advisors is Compensated
Like all of our projects, Lantern Capital Advisors charges an
hourly fee which is paid and weighted towards the success of the
overall project. The project isn't complete until financing is
obtained. Our success as a firm depends on our ability to
achieve successful results for our clients.
Unlike most investment bankers and advisors,
Lantern’s compensation is not based on the amount of financing
raised or the overall purchase price of the Company. While that is a
common industry practice, Lantern Capital Advisors believes this
compensation structure presents a conflict of interest for our firm and
works
against the best interests of the management team.
Download from
CFO.com
August, 2008
Chris Risey -
Atlanta
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