“Management Buyouts”		«BACK
	by Dennis L. Monroe and Timothy R. Ring
	from Franchise Times Articles, April 2001 Issue

Contributing to the opportunity is also the tendency and demand of the market place for large multi unit operators to focus on business segments or operations that will significantly grow earnings per share. The concept being the market pushes management to focus on what's hot and new business segments and concepts offering superior growth. Essentially, the driving force of the market ignores other inherent values in a multi unit operator leaving management the opportunity to seize value that shareholders and parent company management ignore.

It appears there is an appetite among equity investors, particularly venture funds, to be involved with undervalued or underperforming retail multi-unit assets so availability of funds for both the equity and debt side seem available.

With this background in mind, what exactly is involved in a management buyout? The following are key elements in a management buyout:

1. Management Team. A management team that encompasses the broad base of key executives for the company's success is a critical element in a management buyout. Strong operational and financial management skills are a must. If the company has been underperforming, it is very difficult to convince investors that the management team that created an underperforming company can all of a sudden, with ownership involvement in the company, perform at a different level. In many instances it is not management that produced the issue but rather improperly capitalized companies leaving no room for capital expenditures for growth and re-imaging. It is key to fully explain that management involved in the transaction is not the management that created problems for the company. More often than not, however, in the current environment too much debt leverage has been the catalyst for the dismal earnings and sales declines based on the inability to open new operations or re-image to current customer and market requirements.

2. Pricing. The market has driven down pricing in most multi unit segments. For management buyouts the price must be, in most cases, below what the company may receive from a strategic buyer. Management in most cases does not have the resources necessary to pay top price or the ability to lever other assets. Therefore, in these transactions it is common for the selling entity to carry paper or strips of equity or hybrid equity. We are seeing in these transactions purchase multiples of 2.0 to 3.5 times earnings before depreciation, interest and taxes.

We have been advisors to a number of management buyouts where the management team has actually had the inside track. This is much more difficult if it is a public company because a public company is forced to take the highest and best offer. But in some cases, like the Pollo Loco sale, the company did not take the highest price offered, but instead took the price from a buyer they believed could perform. Almost uniformly in a management buyout a public company is forced to take the highest price. In the case of a private closely-held company, the shareholders have the ability to take a lower price so as to maintain some of the intangibles that the company represents.

3. New Business Plan. In order to have a successful management buyout, the management team must have a new and feasible business plan. In many cases when we have been working with management, we have seen business plans that reflect a total change in the company's approach to its business. For instance, we have seen cases where a company that is predominantly a franchisor decided they would go to a corporate store strategy and vice versa. In most cases when there is a dramatic change in strategy, the investor and the selling company have to question whether management really has the knowledge and vision to complete a successful management buyout. The key element is to demonstrate from other market performance or partial performance how the company can perform at a higher level.

4. Incentives. It is key in management buyouts that the management team, even the middle management team, has adequate incentives and ownership interests to motivate performance at an interested and high level. This can be accomplished through restricted stock, stock appreciation rights and even an ESOP buyout arrangement (which should definitely be considered in this whole process).

5. Financing. Financing for these transactions take on a variety of forms and structures from securitized and straight traditional debt, straight equity and hybrid equity, mezzanine strips, subordinated debt, ESOP money, and seller paper. It is critical in a management buyout that the company not be over-levered. The business case studies are filled with overleveraged management buyouts that have not been successful. The company should have adequate working capital and capital expenditure facilities to move forward and grow, along with proper resources to make it through all economic cycles and unforeseen events. This normally requires a cooperative and suitable equity partner. Financing for management buyouts tend to more complex in structure and it is critical to have experience advisors who understand and appreciate all of the variables and intricacies. It is always beneficial that previous owners carry some subordinate debt as part of the acquisition price. This provides more flexibility to the management team and also creates the kind of margin for error that is necessary in any kind of leveraged transaction.

6. Equity Contributions by the Management Team. In almost all cases, investors, lenders and sellers want to see the management team have some "skin in the game." This skin is something more than sweat equity. This means real hard dollars. It is very seldom in today's world that a management buyout can be completed unless management is willing to come up with some cash. It does not have to be a great deal of cash, perhaps less than 5% but it is necessary to have a successful acquisition. In summary, management buyouts are a wonderful way to keep a good company that is presently underperforming or underpriced moving forward which in turn provides the management team with incentives for growth. This transaction structure provides a wonderful exit strategy for existing owners without going through a lot of negotiation hassles given management familiarity with operations, and in most cases without continued liability after the sale. We see this trend continuing and giving the market wonderful opportunities. Again, it is key to have advisors who have done this type of transaction and who understand multi-unit management buyouts.