Structuring An Effective Management Team Buy-Out
What can a sole business owner do if there are no successor owners or family members to take over the business when he or she retires, dies or becomes disabled? A management team buy-out may provide a solution.
A business succession plan provides the business owner the assurance that a successor owner will purchase the business at a mutually agreed upon time and price. Such a plan provides security and predictability. When a business has multiple owners, the natural successors to own and operate the business are the owners who remain after an owner dies, retires or becomes permanently disabled. In family businesses, the next generation of family members usually is called upon to provide successor ownership and management.
But when there is a sole principal owner and no family member to succeed that owner, possible successors include key employees and managers who actively are involved in the business.
One problem with creating a buy-sell agreement between the principal owner and key executives who form the management team of a business is that the management team does not remain constant. These executives often come and go as professional opportunities present themselves. How can the owner be assured that the key executives on the management team will buy the business when the owner wants to, or must, sell out? And just as important, where will the executives get the money to buy the business?
The owner and management team can enter into a buy-sell agreement that obligates the management team to purchase the owners business interests at a price established in the agreement whenever certain “trigger” events occur–such as the owners death, permanent disability or retirement.
To provide the security and predictability the owner needs, and the flexibility the executives need to enter and leave the business (and the management team buy-out agreement), the parties can create a trust or partnership that has the obligation to purchase the business interest when a trigger event occurs. The executives, or management team, would be the beneficiaries of the trust or partners in the partnership.
When a triggering event occurs, the trust or partnership would buy the principal owners business interests. Once the transaction is complete, the trust or partnership would distribute the business interests–usually stock–to the beneficiaries or partners.
Funding The Buy-Out. An installment sale can be used in which the management team pays the departing owner over a period of years from business revenues. This, however, requires the owner to spread out the receipt of his or her money and creates the possibility that the business, and the source of the payments, may fail once the owner no longer has control. For lifetime buy-outs because of the principal owners retirement or disability, an installment sale may be the only practical way to structure the arrangement.